Electronic Lending Made Mandatory?

CU360
October 20, 2009 | COMMENTS

Last year's failures of large financial institutions and Wall Street firms point out that regulators are ill equipped to view institutional loan portfolios in ways that help them monitor the global financial system. The collapse of Lehman Brothers, for example, and its relationship with numerous financial firms around the world caused global credit markets to grind to a halt.

This could have been prevented, according to USBanker, if regulators had the tools in place to effectively view complex debt instruments and the links between the financial institutions that securitize, hold, and insure them.

Currently available data provide regulators with only a snapshot of the loans held by a single institution. It's not a complete picture of the entire portfolio, let alone an understanding of the risk faced by financial institutions that hold securities based on these loans. This problem is evident when looking at the institutional path mortgage loans take.

First, the loan is originated by a lender regulated by one of a number of agencies, such as the NCUA or FDIC. Next, it's sold to Fannie Mae or Freddie Mac, which are regulated by the Federal Housing Finance Agency. Then the loan is securitized and resold to organizations that are overseen by the Securities and Exchange Commission. With no mechanism in place requiring these agencies to share data and communicate with one another, regulators are unable to reasonably access the data needed to assess systemic risk in the financial services industry.

The solution to this dilemma, suggests USBanker, is the widespread adoption of electronic lending technology and open industry standards.

In electronic lending, all of the loan documents are drawn, processed, signed, and stored electronically. This computerized data flow means that all the data used to originate a loan, from credit scores to information on the collateral asset, can follow the note automatically. In the current system, the thousands of data points in a loan file are reduced to a handful by the time a securitized asset is sold. The paper involved in the process means that data is lost or destroyed during each step.

Electronic tracking, however, requires implementation of technologies that create and manage electronic loan assets. This would increase transparency in ways that would allow regulators to view assets online, while also providing the means to document trouble spots in an efficient, uniform manner. And the paperless nature of electronic lending would facilitate cost savings for the financial industry in everything from reduced audit costs to the time required to process each transaction.

Electronic lending technology would allow regulators to easily audit institutions, thus enabling investors to see on a computer screen thousands of different data points within loans that make up their portfolio for an accurate portrait of risk.

This could come as an add-on to the current rating systems. Institutional transparency could be scored by such criteria as inclusion of standardized data using existing industry open standards, total number of data points shared with auditors, percent of portfolio in electronic form, and availability of prospectus data in standardized electronic format.

Much like law enforcement agencies need to cooperate and share data, this would allow regulatory bodies to connect the dots and have visibility into the systemic risk. Standardization of data would facilitate cooperation and collaboration between regulators through the sharing of source data.

Whatever regulatory structure Congress eventually adopts, electronic lending technology could eventually be part of it because of the value such tools can provide to regulators. So far, however, no such proposal has been included in draft legislation.