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Two top banking regulators, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC), have proposed a controversial rule that could effectively eliminate regulations on payday lending and interest rates—a huge gift to predatory consumer finance. The rule could become the most consequential deregulatory action of the Trump presidency, consigning millions of Americans to newly legal loansharking.
The rule would overturn a 2015 court decision that has proven surprisingly durable, even amid the conservative drift of the courts. It would codify a doctrine known as “valid-when-made,” which critics consider invented by debt collectors and their allies out of whole cloth. In practice, it would mean that any payday lender could evade interest rate caps or other state-level restrictions by funneling their loans through a chartered bank. This is sometimes known as a “rent-a-bank” scheme
“The FDIC and OCC risk sending a green light for predatory lending when the agencies should be doing the opposite: making clear that the banks you supervise cannot rent out their charters to help predatory lenders make usurious loans that create debt traps for consumers or small businesses,” wrote 21 consumer advocacy groups in a letter to the regulators last month.
The rent-a-bank scheme works like this: More than half of all states have interest rate caps on consumer loans. They have been largely rendered irrelevant for credit cards, thanks to a court ruling that allows banks to adopt credit card interest rates in the state where they are headquartered. That’s because the National Bank Act of 1864 pre-empts state usury caps for national banks that do not reside in that state.
This pre-emption holds for banks only. Non-bank payday lenders try to get in on the action by putting a bank’s name on the loan, allowing them the pre-emption protection. One company engaged in this is Elevate Financial. Its line-of-credit product, Elastic, uses Republic Bank, which is chartered in Kentucky, to make the loans. Elevate supplies the underwriting software and therefore controls who gets a loan. Republic Bank holds onto the loans, but then sells a 90 percent “participation interest” to an affiliate of Elevate. Functionally speaking, Elevate issues and effectively owns the loans, but it has a legal fig leaf that enables it to point to Republic Bank as the actual lender.
This enables Elevate to sell Elastic, which its financial disclosures say carries an annual percentage rate of 109 percent, in states like Minnesota, Montana, and Oregon, which cap interest rates at 36 percent. It also allows Elevate to sell what is effectively a payday lending/installment loan product called Rise in states where payday lending has been banned, like Arizona. FinWise Bank, chartered in Utah, has also been helping Elevate and Opploans, a separate company, make loans with interest rates as high as 160 percent.
Rent-a-bank schemes have ebbed and flowed over the years. In the early 2000s, several states, including North Carolina, cracked down on them. Lenders have cagily not pursued the practice in states with a history of actually enforcing their interest rate caps.
Rent-a-bank schemes could also open the door for financial technology (or “fintech”) companies to practice online lending at whatever usurious interest rates they wanted. “We have seen it more recently in the online space,” says Lisa Stifler, director of state policy for the Center for Responsible Lending.
But a 2015 court ruling in Madden v. Midland Funding threatened the whole effort. In that case, borrowers argued that any loan sold by a bank to a non-bank doesn’t get the pre-emption-from-interest-rate-caps protection. The 2nd Circuit Court of Appeals agreed, and the Supreme Court decided not to review the case in 2016.
Critically, this could also apply to the securitization process, when a bank sells a loan into a trust that creates bonds for investors. Some state consumer usury caps are as low as 16 percent in New York and 17 percent in Arkansas. So this ruling threatened to cap a whole host of interest rates in any transaction where the bank didn’t hold onto the loan, including auto loans, private student loans, and other debt (mortgages are exempted due to separate legislation). Contrary to industry whining, this would not render the entire securitization model obsolete. But it would empower state usury caps to restrict excessive, predatory lending.
Since the Madden ruling, financiers have been desperate to overturn it in some fashion, either through litigation, legislation, or regulatory change. House Republicans have introduced legislation on this (troublingly, with New York Democrat Gregory Meeks as a co-sponsor), but to no avail. With the Trump administration’s ascendance, however, the industry saw its chance.
The FDIC and OCC have been hinting at their position on Madden for some time. In September, the regulators jointly filed an amicus brief in a minor small business bankruptcy case in Colorado. In it, they defend a 120.86 percent small business loan issued by a community bank in Wisconsin that got transferred to a predatory non-bank unit called World Business Lenders. The regulators state plainly that as long as the high-interest loan was “valid when made,” it can be transferred to any non-bank lender. They call this “longstanding” rule “well-settled law.”
According to Adam Levitin, a professor at Georgetown University Law Center, there is no such “valid-when-made” doctrine that appears anywhere in the historical record until quite recently. It’s just a vehicle to avoid democratically passed interest rate limits in the states. Indeed, the 2nd Circuit rejected valid-when-made in the Madden case. “It is a modern invention lacking historical roots,” Levitin writes.
The intent of intervening in an obscure bankruptcy case seemed to be to elicit a split ruling on valid-when-made, in order to get the question back before a newly configured Supreme Court. But instead of waiting for that conclusion, the bank regulators have prepared a frontal assault.
The proposed rule, which the OCC announced Monday and which the FDIC will vote on today at a board meeting, would clarify the “valid-when-made” doctrine to assert that loans originated by a bank would remain pre-empted from any interest rate caps, even if purchased by a non-bank. All Republicans on the House Financial Services Committee have urged this step. OCC claims the new rule will “address confusion” stemming from the Madden ruling. The FDIC, where Republicans hold a 3-1 advantage on the board, is expected to approve the proposed rule.
If finalized, the rule would allow any online lender to funnel its loans through a bank and charge whatever interest rate it chooses, regardless of state limits. Payday lenders could similarly operate in states where payday lending is outlawed, as long as they ran the loans through a bank.
Consumer advocates, who had been urging bank regulators to crack down on rent-a-bank schemes, have reacted with outrage. “States have had the power to limit interest rates since the time of the American Revolution,” said Lauren Saunders, associate director at the National Consumer Law Center, in a statement.
This brazen move to undermine state usury laws comes right as a bipartisan House bill would limit interest rates on consumer loans nationally to 36 percent. Glenn Grothman, a Republican from Wisconsin, co-sponsored the bill. California also recently passed a 36 percent interest rate cap that will go into effect on January 1.
Fintech lenders have openly discussed on earnings calls using rent-a-bank schemes to avoid the California cap. “Banks don't have the same limitations as a state license vendor would,” said an official from Elevate Financial on one of the earnings calls. “[T]hat’s one of the nice things.” Enova International, another payday lender, told investors, “we will likely convert our near-prime product [NetCredit, a payday product with 155 percent interest rates] to a bank-partner program, which will allow us to continue to operate in California at similar rates to what we charge today.”
Advocates have argued that the regulatory agencies’ proposal could violate the law. “When the Dodd-Frank Act passed, Congress limited the bank regulators’ authority to pre-empt state consumer protection laws,” says Stifler, of the Center for Responsible Lending. “There’s a question as to whether they have the ability to do this that we’re exploring.”
Under the law, the banking regulators must take public comment for 60 days before finalizing the rule.
