Federal Rent-a-Bank Bill May Harm Financially Distressed Consumers

By Ricardo Quinto

Recently, it was announced that the U.S. House of Representatives is likely to vote, the week of February 12, on H.R. 3299, the so-called “Madden fix” bill which would preempt state interest rate caps and open the flood gates to online predatory lending. The bill is spearheaded by U.S. Reps. Patrick McHenry (R-N.C.) and Greg Meeks (D-New York).

If passed into law, predatory “fintech” lenders will capture more vulnerable borrowers in a debt trap, which already drains more than $8 billion a year from the working poor. H.R. 3299 supporters falsely claim that this bill will help underserved urban and rural areas by expanding access to credit. The reality is that it will expand unchecked predatory lending.

The so-called “Madden fix” bill would make it easier for predatory payday lenders and other non-banks using rent-a-bank arrangements or partnerships to override state interest rate caps and make loans of 300% annual interest or higher. Unaffordable payday loans and other triple-digit interest predatory loans have devastating consequences for already financially distressed borrowers, trapping them in a cycle of debt and increasing the likelihood of delinquency on other bills, delayed medical care, bankruptcy, and eviction.

This bill gravely threatens the strongest available tool against predatory lending: state interest rate limits. The bill would override the Second Circuit’s 2015 Madden v. Midland decision, which held that a debt buyer purchasing charged-off credit card debt could not add additional interest above state interest rates. This decision was consistent with longstanding law that nonbank creditors are covered by state interest rate limits. This bill would effectively reverse that decision, permitting predatory non-bank lenders to use banks’ preemption rights to violate state interest rate caps — including in the 15 states plus the District of Colombia whose state interest rate limits currently save borrowers over $2.2 billion annually in payday loan fees.

Banks benefit from preemption of state interest rate caps through the National Bank Act and related laws. But outside of mortgages, nonbank lenders have always been subject to state interest rate caps. Through rent-a-bank arrangements, a nonbank lender uses a bank to originate its loans and attempts to evade state interest rate caps. For example, high-cost online lender Elevate uses Republic Bank to make loans that exceed state interest rate caps. Elevate does not disclose an APR for its “Elastic” product, but a $380 advance repaid with monthly minimum payments would cost $480 to repay over five months, which carries a fee-inclusive annual rate of about 100% — nearly three times the 36% legal rate approved by voters in Montana and S. Dakota, where the Elastic product is offered.

The Office of the Comptroller of the Currency, Office of Thrift Supervision, Federal Reserve Board, and FDIC all shut down rent-a-bank lending in the early-to-mid 2000s. Comptroller John D. Hawke, who served from 1998-2004 under Presidents Clinton and Bush, called the schemes “an abuse of the national charter” and stated, “It is a matter of great concern to us when a national bank essentially rents out its charter to a third-party vendor who originates loans in the bank’s name and then relinquishes responsibility for how these loans are made… We are particularly concerned where an underlying purpose of the relationship is to afford the vendor an escape from state and local laws that would otherwise apply to it.”

Currently, it does not appear that national banks are engaged in rent-a-bank schemes, but some state-chartered banks are. Federal regulators may not continue to contain these schemes, particularly if this legislation were to become law.

More than 150 organizations, including consumer advocate, civil rights, and faith organizations across the country, have come out against this rent-a-bank. In addition, when this provision was included in other legislation earlier this year, twenty State Attorneys General warned that the provision “would restrict states’ abilities to enforce interest rate caps. It is essential to preserve the ability of individual states to enforce their existing usury caps and oppose any measures to enact a federal law that would preempt state usury caps.”

State interest rate caps have not impacted responsible marketplace loans. The leading marketplace lenders do not make loans above 36%, and the majority of their loans are well below that rate, comfortably within state caps. Only the highest rate marketplace loans are impacted, and only then in some states. But the rent-a-bank bill will permit predatory lenders to abuse bank partnerships to enable high-cost loans of 100% APR or higher.

There are signs that some online lenders are making large numbers of loans that consumers will not have the ability to repay:

  • News reports show that delinquencies and charge-offs at marketplace lenders are rising.
  • One lender has had so many of its loans fail, that it had to repay investors for their losses in consecutive securitizations of the loans it bundled up and sold to Wall Street.
  • One online lender reportedly failed to verify a borrower’s income for a full two-thirds of its loans in 2016.
  • Moody’s credit-rating firm likens this industry to mortgage lending in the years leading up to the 2008 financial crisis in that “the companies that market the loans and approve them quickly sell them off to investors,” relieving themselves of the risk of the loan later going bad.
  • Many marketplace lenders make very large loans of $30,000-$50,000 or higher, and even 36% is a very high rate for such loans. Many states have tiered rate caps in recognition that interest becomes more unaffordable the larger the loan. Iowa, for example, caps interest at 21% for loans over $10,000.

This bill would weaken lenders’ incentive to underwrite properly by making it easier to make high-rate loans. High interest rates result in misaligned incentives that can lead to lender profits even with borrower catastrophe. Skewed incentives are already a problem in the marketplace loan industry. This bill could make that problem worse.

The only evidence provided that the Madden decision has purportedly affected access to credit is one research paper that shows, at most, a trivial impact. Yet this bill would dramatically weaken lenders’ incentive to underwrite properly by making it easier to make high-rate loans that borrowers don’t have the ability to repay.

The rejection of rent-a-bank models is consistent with Congressional action in the Wall Street Reform Act. While reaffirming the principle of bank preemption of some state laws, Dodd-Frank reversed a Supreme Court decision that extended preemption to operating subsidiaries of national banks, limiting preemption to the bank itself. Rent-a-bank schemes are even less connected to actions of the bank itself than activities of bank subsidiaries are. Thus, the effort to extend preemption to nonbank entities runs counter to Dodd-Frank.

A Senate companion bill, S. 1642, was introduced by U.S. Senator Mark Warner (D-Va.) If you’d like to speak with a member of our policy team, please email me at ricardo.quinto@responsiblelending.org.

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