Fintech innovation operates in an ever-evolving financial regulatory landscape. Regulators are stepping up scrutiny of non-banks, particularly marketplace lenders, even as the new Consumer Financial Protection Bureau (CFPB) establishes its mandate and rules. This shifting landscape carries regulatory implications for traditional banks weighing fintech partnerships. In this blog series, Mirador will recap the latest regulatory developments with potential impact for bank-fintech partnerships.
Online Lending: Balancing Innovation with Oversight
On July 12, a key House Subcommittee on Financial Institutions and Consumer Credit held an important hearing on fintech and the online lending market. Digital marketplace lenders, traditional banks and consumer protection advocates all testified into the record, raising common concerns about regulatory uncertainty, transparency and serving the unbanked and underbanked. By the end of the hearing, it was clear that subcommittee members support innovation in financial services, but they also want to see a system incorporating regulatory oversight and strong consumer protections.
Many witnesses testified to the opportunity for banks and credit unions to partner with fintech startups. Rob Nichols, CEO of the American Bankers Association, came out as a strong advocate for such partnerships: “Today, banks of all sizes are innovating and partnering with technology-powered startups to deliver innovative products and services to their customers…. When banks innovate and partner with startups to deliver new technologies their customers win.” (Read Nichols’ full testimony here.)
By working directly with innovators, traditional lenders can better compete with alternative lenders who can process applications and deploy capital rapidly – and do so in a fully regulated environment with adequate oversight. These partnerships offer perhaps the most viable solution moving forward to the regulatory conundrum online lending poses.
Is Rent-a-Charter Lending Illegal?
Sometimes the Supreme Court rules through not ruling, and this was the case with the Court’s decision last month not to consider the Madden v. Midland case.
Thanks to the National Bank Act, banks with national charters can export what is known as usury laws, statutory interest rate caps, from their state of incorporation. Many banks with credit card products will incorporate in a state with friendly usury laws, including states with no caps on interest rates.
Another common practice is known as “rent-a-charter” where a non-bank issues loans by partnering with a bank located in a state with advantageous usury laws to issue loans. In this partnership, the banks will handle the underwriting and issue the loan and the non-bank will purchase those loans to keep on their books or package and sell to investors.
In the Madden v. Midland case, a non-bank, debt collection agency was sued for collecting on a credit card balance when the interest rate associated with the card was higher than the caps in the debtor’s home state. The Second Circuit Court of Appeals found that when the bank sold the interest in the debt, the rights under the National Bank Act were severed, leaving the purchasing non-bank to collect on an illegal debt. These precedents leave a great deal of uncertainty for entities using the “rent-a-charter” model.
This case is further fueling efforts to create a national charter for non-bank entities in the financial services space. For traditional banks and credit unions, this decision could impact how they handle their debt collection services. Smaller institutions, lacking debt collection resources, may sell their delinquent debts to a collection agency. Based on the ruling of the Second Circuit, this setup for debt collection may no longer be a viable option for banks.
Proposed Rules Too Rigid According to Banks & Credit Unions
Last month the Consumer Financial Protection Bureau (CFPB) proposed small-dollar lending rules to curb predatory lending practices known as “payday lending.” With the goal of stopping debt traps and preventing consumers from becoming trapped in high-interest, short-term debt cycles, the CFPB proposed aggressive rules to ensure lenders are assessing ability to repay when issuing these small dollar loans.
While most of the targeted lending is conducted through non-bank entities, the main trade association for the community banks, the Independent Community Bankers Association (ICBA) and the Credit Union National Association (CUNA), expressed their concerns in a letter to the CFPB administrator, Richard Cordray. The two trades express their mutual concern over the complexity of the proposed rules and the ability to repay criteria under the CFPB’s proposed “full-payment test”.
The “full-payment test” proposal includes potentially burdensome requirements on community banks and credit unions for underwriting these small dollar loans. Frequently, small-dollar credit is provided to the bank and credit union customers based on their relationship with the institution. Forcing new underwriting requirements on supervised banks and credit unions is unnecessary and could harm consumers access to credit according to the trade associations.
In their letter, ICBA and CUNA stated plans to further comment as individual trades on the full proposal.