CFPB, alternative lender Upstart end no-action letter

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Diving brief:

  • The Consumer Financial Protection Bureau (CFPB) ended a no-action letter from alternative lender Upstart on Wednesday, at the company’s request.
  • “Upstart has requested termination because it wants to make urgent model changes that are not possible if the CFPB had to carry out the appropriate level of oversight and review”, CFPB written in order by Wednesday.
  • Upstart’s move comes after the CFPB said last month that it would place less emphasis on its no-action letter policy and product development sandbox, which the bureau said “proven to be ineffective.”

Overview of the dive:

The CFPB, since 2014, allows individual companies to apply for no-action letters protecting them from regulatory action while they develop specific products in a safe harbor. The truncation of Upstart’s no-action letter leaves the program without its longest-serving participant – although participation has been rare.

Upstart, which uses artificial intelligence and alternative credit data such as a borrower’s education and work history as part of its formula to determine creditworthiness, has become the first company to obtain a letter of no three-year CFPB action in 2017. The CFPB issued a second letter for an additional three years in November 2020.

Upstart informed the CFPB in April, as required by the 2020 letter, that it intended to add several new variables to its underwriting and pricing model. The CFPB, however, requested more time to review and “rigorously assess the implications of the changes”.

The CFPB the following month created its Office of Competition and Innovation, which aimed to organize “incubation events” such as sprints, hackathons, tabletop exercises and war games to solve barriers to innovation – instead of forging innovation agreements such as no-action letters with individual companies.

Three days later, Upstart asked to shorten the term of its no-action letter to 18 months – ending it immediately. (The request was dated May 27, the Friday before Memorial Day weekend. The 18-month period would end on May 30, a holiday.)

“Our request was driven by the need to keep our risk models accurate and up-to-date during a time of significant economic change,” said Nat Hoopes, Upstart’s vice president and head of regulatory affairs and public policy, in a statement. blog post on Wednesday. .

Hoopes said the company has been in touch with the CFPB’s new innovation office “and will continue to pursue a transparent and cooperative relationship with the CFPB and other financial regulators.”

In its order, the CFPB said Upstart “correctly identified” that its review “would prevent them from making prompt business decisions regarding its model.”

Upstart’s relationship with the CFPB has proven fruitful. The alternative data model the company developed helped it approve 27% more loans – with an average 16% lower annual percentage rate – in the first two years of its no-action letter period , reported Upstart in 2019.

“We have designed our Fair Lending Program to meet or exceed CFPB’s high standards of compliance under the Equal Credit Opportunity Act (ECOA). Process and rigor have made us a better company,” Hoopes wrote in Wednesday’s blog post. “We appreciate the time, care and thought put into Upstart by Bureau staff. [no-action letter] for the past six years. »

The CFPB, in its order, was careful to note, however, that the bureau “never endorsed Upstart’s model.”

“There is a risk that the public may misinterpret the [no-action letter] to suggest that the CFPB has concluded that Upstart’s model is ECOA-compliant,” the bureau wrote in its order, adding that such an assessment would require further analysis.

Upstart, meanwhile, said it would “continue to rigorously test each loan application for fairness, including pre-testing each model update before implementation.”

“Effective cooperation between government and fintech innovators remains essential to improving financial access for the millions of borrowers left behind by the current U.S. credit system,” Hoopes wrote on Wednesday.

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