FDIC Issues Guidance that May Curtail Bank Purchases of Marketplace Loans
On November 6, the Federal Deposit Insurance Corporation (FDIC) issued Financial Institution Letter FIL-49-2015, titled “Advisory on Effective Risk Management Practices for Purchased Loans and Purchased Loan Participations.” Though billed as an update to an advisory letter issued in 2012, the new guidance requires all FDIC-supervised banks and savings associations to implement a number of new procedures before purchasing loans or loan participations that are originated by third-party nonbank entities. These restrictions would include the purchase of or participation in small business loans originated by marketplace lenders. In fact, the letter cautions supervised entities from relying on marketplace platforms that the FDIC believes do not provide sufficient information to potential investors:
[A]n increasing number of financial institutions are purchasing loans from nonbank third parties and are relying on third-party arrangements to facilitate the purchase of loans, including unsecured loans or loans underwritten using proprietary models that limit the purchasing institution’s ability to assess underwriting quality, credit quality, and adequacy of loan pricing. In some situations, it is evident that financial institutions have not thoroughly analyzed the potential risks arising from third-party arrangements.
The three pages of new guidance require a variety of procedures be implemented, including:
1. The new guidance significantly expands the policies a bank must establish before purchasing, such as:
- Establishing detailed procedures for purchased loans and participations
- Defining loan types that are acceptable for purchase
- Requiring board of directors approval of arrangements with third-parties to purchase loans and participations
Additionally, financial institutions are required to establish ongoing risk management processes for purchases made through third-party relationships.
2. The new guidance requires enhanced independent analysis of purchased loans and participations. A purchasing institution must ensure that it has “the requisite knowledge and expertise specific to the type of loans or participations purchased and that it obtains all appropriate information from the seller to make an independent determination.” The loans and participations must also be determined to be consistent with the bank’s appetite for risk. The letter states that this analysis must be done in-house and may not be contracted out to a third-party.
3. A supervised bank must also perform due diligence on the validity of a third party’s credit models if the bank relies on the model for credit decisions. A bank is permitted to subcontract this due diligence to third-parties but is still required to review the model validation to ensure it is sufficient.
The new guidance will undoubtedly increase the costs FDIC insured banks incur to purchase loans and loan participations originated by small business marketplace lenders. What effect these costs will have on current and future bank involvement in marketplace lending remains to be seen.Last modified: November 20, 2015
Patrick Siegfried is the author of usurylawblog.com and smallbusinessfinancelaw.com. Patrick is a practicing attorney in Bethesda, Maryland. Patrick’s work focuses on issues regarding alternative small business financing. He can be reached at firstname.lastname@example.org