The Federal Reserve, which regulates the biggest banks in the United States, is starting to turn its eye to some of the smallest and newest lenders on the scene.
Startups are partnering with banks both big and small to originate billions of dollars’ worth of consumer loans. That has caught the Fed’s eye.
“Right now, this type of business is not that large, but it has potential to be disruptive and could be very large going forward,” St. Louis Federal Reserve Bank President and CEO James Bullard told Business Insider last week.
“We certainly want to learn as much as we can about it,” he told Business Insider, so as to understand “to what extent are we inappropriately allowing competitive advantage to one group of lenders versus another.”
Online lenders match would-be borrowers with banks, hedge funds, and even individuals—with some of these loans later repackaged as asset-backed securities. That, though, has the Fed concerned certain lenders partnering with startups may have an advantage over their rivals.
Some of the leading players in the space will be at Bullard’s bank in St. Louis on Wednesday and Thursday to meet him to discuss community banks’ changing role in lending this week at an annual conference. This will include an executive from Lending Club, and Gilles Gade, CEO of Cross River Bank, one of the key banks supporting online lending.
Cross River is one of several Web-only or smaller community banks processing loans to consumers through online portals like Lending Club, Prosper, and PayPal’s small business lending arm.
Other firms in the space include WebBank, Union Bank, Radius Bank, Wisconsin-based Bank of Lake Mills, and Trust Company of Lincoln, in Nebraska. BofI Federal Bank in California, another branchless bank, also works with startups processing loans.
Big banks have been eager to step in and buy loans in enormous gobs too. Citigroup agreed to a $150 million deal with Lending Club to finance its loans; Citizens Bank bought $200 million in loans from student loan refinancing service SoFi and plans to keep buying more. This has turned peer-to-peer lending into an industry increasingly dominated by big Wall Street firms.
“[Wall Street] Banks don’t have the time to underwrite small loans,” said Georgia Quinn, an industry attorney and founder of iDisclose, a startup providing legal services and advice to startups. “It’s credit they’re not willing to issue—serving people Bank of America doesn’t want to give the time of day to.”
Then there is peer-to-peer based asset-backed securities, which are marketed to hedge funds and other institutions. For ABS offerings, Goldman Sachs and Morgan Stanley are among the ‘warehouse providers’ in the space.
A court decision in May could potentially hurt startups like Lending Club, as well as the investors that own the loans they originated. They are now facing a long battle in a New York appeals court to overturn a decision that could scare hedge funds and other institutional investors away from their supposedly safe securities.
Gade feels concerns over the consumer loans originated by startups are overblown. “They’re a drop in the bucket,” he said. “Even if they fail, nothing is going to happen to the economy.”