Q: What should a bank consider when entering a marketplace lending arrangement with nonbank entities?
A: When engaging in marketplace lending activities, a bank’s board and management should understand the relationships among the bank, the marketplace lender, and the borrowers; fully understand the legal, strategic, reputation, operational, and other risks that these arrangements pose; and evaluate the marketplace lender’s practices for compliance with applicable laws and regulations. As with any third-party relationship, management at banks involved with marketplace lenders should ensure the risk exposure is consistent with their boards’ strategic goals, risk appetite, and safety and soundness objectives. In addition, boards should adopt appropriate policies, inclusive of concentration limitations, before beginning business relationships with marketplace lenders.
Banks should have the appropriate personnel, processes, and systems so that they can effectively monitor and control the risks inherent within the marketplace lending relationship. Risks include reputation, credit, concentrations, compliance, market, liquidity, and operational risks. For credit risk management, for example, banks should have adequate loan underwriting guidelines, and management should ensure that loans are underwritten to these guidelines. For compliance risk management, banks should not originate or support marketplace lenders that have inadequate compliance management processes and should monitor the marketplace lenders to ensure that they appropriately implement applicable consumer protection laws, regulations, and guidance. When banks enter into marketplace lending or servicing arrangements, the banks’ customers may associate the marketplace lenders’ products with those of the banks, thereby introducing reputation risk if the products underperform or harm customers. Also, operational risk can increase quickly if the operational processes of the banks and the marketplace lenders do not include appropriate limits and controls, such as contractually agreed-to loan volume limits and proper underwriting.
To address these risks, banks’ due diligence of marketplace lenders should include consulting with the banks’ appropriate business units, such as credit, compliance, finance, audit, operations, accounting, legal, and information technology. Contracts or other governing documents should lay out the terms of service-level agreements and contractual obligations. Subsequent significant contractual changes should prompt reevaluation of bank policies, processes, and risk management practices.