Digital lending is a game changer. For many centuries, regulated banks had a complete monopoly on that business, with absolute discretion on how to lend, to who, where, and on what terms, with very little oversight from a consumer protection perspective. As parts of banking began to digitise and brought more choice, transparency, and price competitiveness, new entrants began to enter, leading a sustained attack on the high net interest margin obtained by incumbents.

Listed below are the key regulatory trends impacting the digital lending theme, as identified by GlobalData.

Open banking enabled lending

As open banking initiatives mature worldwide, lenders are moving from manual, portal-based data ingestion to direct integration into credit risk, affordability, and customer management rules. Several aggregators are now adding open banking to their customer journeys, allowing lenders to use open banking data at the quotation stage, eliminating the potential confusion of a late-stage rejection. This gives all parties more predictability and transparency around decisions.

It is also true that regulators worldwide are favouring open digitisation as an effective way to determine affordability for vulnerable customers, rather than traditional consumer protection legislation.

New, specific laws on digital lending laws

South Korea became the first country in the world to establish laws dedicated solely to digital lending in 2020. These news rules recognise digital lending as an official sector of the financial industry and provide credibility and validation to digital lenders. However, the new law will allow only the strongest digital lenders to survive and encourage more global institutional funding to flow to South Korea’s market leaders. Many of South Korea’s 250+ digital lending start-ups will likely be unable to meet the new standards and be forced to close by August 2021.

KakaoBank, meanwhile, will likely capitalise on rare growth opportunities for a financial firm afforded by an unusual South Korean regulatory framework. Due to its high user base, it can recommend and collect fees on products offered by third-party partners on a much larger scale, and it also has an advertising business.

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Digital lenders pursuing banking licenses

Many alternative lenders are applying for banking licenses, as they seek to lower origination and funding costs and apply data science to a more mainstream customer base. For example, UK-based digital lender Zopa secured a banking license in June 2020, and US-based digital lender SoFi applied for one in July. It is noteworthy that digital lenders have also sought to accomplish this by purchasing a bank.

In January, LendingClub received approval for its acquisition of Radius Bank, making it the first fintech lender to buy a digital bank. With the purchase of Radius Bank, LendingClub will be able to provide new products and services to its customers beyond just lending.

Non-traditional credit scoring presents heightened data privacy concerns

Non-traditional approaches can rely on metadata from mobile devices and context-aware notifications, which present data privacy issues. Those providers that can obtain the widest range of the most granular data will be able to score users most accurately, which makes real-time, intuitive processes and procedures for consent management key.

Focus on fair treatment

Regulators worldwide are fixated on driving fair, transparent lending decisions. The Biden administration has proposed a new federally backed credit bureau, mandated to ensure credit scoring is not discriminatory and includes alternative data. Housed within the Consumer Financial Protection Bureau, all federal lenders are required to incorporate the federal credit agency’s scoring, including for programmes such as federal home lending, PLUS loans, and other loans that are guaranteed by the US government.

Other issues in the regulatory crosshairs include a lack of transparency around the methodologies used to arrive at scores, as well as the pricing attached to those scores; evidence of erroneous reports to bureaus; and various unintended consequences.

Buy Now, Pay Later (BNPL) in regulatory crosshairs

The explosion of BNPL has attracted regulatory scrutiny. As the competition becomes fierce, merchants are gaining more choices of BNPL, both in provider types (fintechs or banks) and the economics of their business model. Merchants typically pay their BNPL partner a flat fee representing a percentage of a consumer’s transaction, but as merchants gain more negotiating power, they may seek to drive those fees down.

On the other hand, if BNPL becomes ubiquitous, persistently high fees could lead to regulatory scrutiny because the credit card processing fees merchants pay card networks are lower, with Visa Inc’s credit card interchange fee ranging from 1% to under 3%, for example. Consumer advocates have also criticised the BNPL trend as another entry point into a debt trap. The UK’s Financial Conduct Authority stated in February that the sector has significant potential for consumer harm.

Imprecise rules for e-sign

For years incumbent banks had not digitised key aspects of their lending applications as regulators insisted on wet signatures. When regulators became more accommodating, it was often a bank’s compliance department and their interpretation of the regulation, not the regulation itself, that obviated modernisation efforts. Back in 2000, the Electronic Signatures in Global and National Commerce Act (E-SIGN Act) was signed, giving electronic consent the same legal force as a wet-ink signature.

However, the legislation is widely considered to have vague and imprecise language around only allowing e-sign when a consumer has “reasonably demonstrated” their ability to receive the electronic disclosure, which has resulted in a sometimes-clunky user experience. In February 2021, legislation was introduced in the Senate (S. 4159 E-SIGN Modernization Act of 2020) that addressed the imprecision in the original legislation, and better enabled banks to make digital loans.

Clamping down on predatory lenders in unbanked sectors globally

Fintech lending in unbanked markets, where millions are excluded from mainstream financial services due to a lack of account history of credit score, has exploded. But it has created real power differentials between suppliers and customers. These sectors have a growing reputation for taking advantage of customers with limited financial literacy and charging exorbitant rates. These providers have also violated implied privacy laws, by harvesting data from phones, with reports of even pressuring debtors by calling friends and family members to embarrass them.

China and crack down on peer-2-peer (P2P)

Beijing cracked down on the P2P industry in 2018, suspending the issuance of licenses for new lenders. More recently it has also hobbled homegrown fintech players such as Ant Group, a dominant force in consumer lending in the mainland. The company’s initial public offering was scuttled by regulators last year as authorities emphasised the need to regulate financial technology.

This is an edited extract from the Digital Lending – Thematic Research report produced by GlobalData Thematic Research.