By Lisa Lambert
WASHINGTON (Reuters) - Hedge funds, banks and insurance companies have recently jumped into "marketplace lending," drawing the attention of U.S. regulators, who said on Tuesday they are concerned that borrowing by consumers and small businesses through online platforms may pose risks to U.S. financial stability.
In its annual review of the U.S. financial system released on Tuesday, the Financial Stability Oversight Council (FSOC) consisting of all the country's financial regulatory chiefs, also said it is watching events overseas, including this week's "Brexit" vote and the turmoil in Venezuela. It also noted that China "is in the midst of long-term transitions in its economy," which could have global implications.
Each year the council addresses an array of risks in cybersecurity in its review. But this year, it expanded its technology focus to include the rapid rise of marketplace lending, which only received a brief mention in last year's report. It also looked at distributed ledgers, commonly called "blockchains."
Alongside turning to institutional investors, marketplace lenders have used public offerings, venture capital, securitizations and bank loans for backing, according to the council.
But their primary tool of underwriting by algorithm has never been tested in a downturn and there is a risk that investors "may prove to be less willing than other types of creditors to fund new lending during times of stress," it said.
The sector's growth could erode U.S. lending standards, the council added. Firms that arrange loans for fees and do not have interest in the transactions could "evaluate and monitor loans less rigorously."
Meanwhile, traditional lenders may lower their standards to compete for borrowers," it said.
The council, created in response to the 2007-09 financial crisis by the Dodd-Frank Wall Street reform act, had said in last year's review that the precursor to marketplace lending - known as "peer-to-peer" financing - should be monitored.
That report did not contain the phrase "distributed ledger systems," an area given its own section in Tuesday's review.
A distributed ledger is maintained by multiple people, with special coding to ensure entries show up across all versions.
Blockchains are promoted as making trades and reconciliations efficient as well as increasing transparency, but FSOC is concerned some users could potentially collude to commit fraud.
It also said risks which are currently hidden could emerge when the ledgers are used on a larger scale, and that blockchains bypass intermediaries such as exchanges which help keep markets in line.
(Reporting by Lisa Lambert, editing by G Crosse and Bernard Orr)