BARRIER TO ENTRY: "Don't give incumbents an unfair advantage," former Treasury Secretary Lawrence Summers said in a speech Wednesday.
BARRIER TO ENTRY: "Don't give incumbents an unfair advantage," former Treasury Secretary Lawrence Summers said in a speech Wednesday. Bloomberg News

Former Treasury Secretary Lawrence Summers argued in a speech Wednesday that incumbent financial institutions are failing to meet the needs of U.S. borrowers, and called on regulators to give technology-focused challengers a chance to compete for customers.

"Let new business emerge," Summers advised regulators. "Regulation is necessary, but only when it is necessary."

"Don't give incumbents an unfair advantage," he added.

Summers serves on the board of Lending Club, the publicly traded firm that is at the forefront of the tech industry's incursion into the lending business, so he has a stake in the outcome of this looming policy debate. As a former Cabinet member under two Democratic presidents, Summers still has considerable influence in Washington.

His remarks were warmly received at the LendIt conference, a gathering of so-called marketplace lenders, including Lending Club, in New York.

Summers, an economist and onetime president of Harvard University, cited the contraction in mortgage and small-business lending by banks as evidence that mainstream financial institutions are no longer meeting the needs of borrowers.

He said it's inappropriate that private equity firms are reaping large profits by renting homes to families that should be able to obtain mortgages. And he argued that mortgage credit is not as easily available as it was during the late 1990s, before the big excesses of the housing bubble.

"We have lived through a problematic era for modern finance, certainly for mainstream finance," Summers said.

The tech sector promises a more efficient and better future, he added, as the systematic use of data enables more accurate credit decisions. San Francisco-based Lending Club and competitors such as Prosper Marketplace function as intermediaries between borrowers and investors, using online lending platforms to underwrite credit.

Summers argued that technology leads to improved borrower experiences, saying that marketplace lenders generally score higher in customer satisfaction than mainstream banks.

He even made the case that the rise of marketplace lending can improve the financial system's stability, noting that marketplace lenders don't use leverage, as traditional banks do. (He failed to note that there's nothing to stop investors in marketplace loans, which include banks, from using leverage.)

"A financial system that is more diverse will be a financial system that is more stable," Summers argued.

Of course, U.S. banks are also using technology to improve their loan underwriting processes. Moreover, many banks are investing in the marketplace lending sector, choosing to partner with the nascent industry rather than competing directly.

Still, it's clear that regulatory gaps have contributed to rapid rise of marketplace lending; to cite just one example, the companies avoid requirements for state lending licenses by involving small banks that hold onto their loans for just a few days.

Many of the chief executives at these upstarts also acknowledge that they're trying to take business from banks, despite the rise of partnerships between banks and marketplace lenders.

So far, federal regulators have largely taken a wait-and-see approach with respect to marketplace lending, declining to issue rules that could stifle growth in the fast-changing sector. Summers' remarks could be read as a call for that cautious stance to continue.

He advised regulators: "Insist on transparency and disclosure, then let consumers decide."

"I am not arguing for laissez faire," he said. "But we also need to recognize that people are not going to improve their credit without getting credit."

Summers also sits on the board of Square, the payments startup, and he sounded Wednesday more like a Silicon Valley CEO than a Washington insider.

"I believe that the financial system, traditional financial system, given its performance, is ripe for disruption," he said. "I believe that it is, more than most sectors, the moment for disruption."

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