By Lydia Beyoud
The House passed a bill Feb. 14 that would better enable fintechs to partner with banks, a business model currently facing uncertainty due to a 2015 court decision.
The bill, which passed 245-171, would restore the “valid-when-made” doctrine, which allows online lenders and other companies to purchase bank loans on the secondary market with the assurance that the original loan terms still apply. The doctrine was called into question by the U.S. Court of Appeals for the Second Circuit’s ruling that said debt buyers couldn’t use their relationship with a national bank to preempt state usury limits ( Madden v. Midland Funding LLC, 2d Cir., 14-cv-02131, 5/22/15). National banks are automatically exempt from interest rate caps set by states.
While H.R. 3299 had bipartisan backing, the political narrative of the bill being a Valentine’s Day gift to the payday lending industry siphoned off Democratic votes. The bill’s supporters say the two issues have nothing to do with one another, and the bill does nothing to change existing prohibitions on banks making usurious loans.
The Senate Banking Committee has yet to move on a companion bill (S. 1642) that may face tough prospects gaining support unless the financial services industry and consumer groups can reach agreement and Democratic lawmakers can be sure they don’t risk being seen as supporting the types of payday lenders that charge triple-digit interest rates and harass borrowers.
The House bill’s cosponsors, Rep. Gregory Meeks (D-N.Y.) and Rep. Patrick McHenry (R-N.C.), tried to strike such a compromise, resulting in a Feb. 12 amendment offered by Meeks that was shot down by the House Rules Committee. It would have codified banks’ responsibility for ensuring their non-bank partners comply with consumer finance laws.
Credit unions and banks already say they perform significant due diligence in doing that, but the amendment potentially would have strengthened regulators’ oversight. However, the amendment seemed to go too far for some financial institutions, while not far enough for consumer advocates, according to multiple industry lobbyists who spoke to Bloomberg Law on background.
“We strongly oppose the bill, with or without the amendment,” Lauren Saunders, associate director for the National Consumer Law Center, told Bloomberg Law by email on Feb. 12, referring to Meeks’ proposal. Consumer advocates offered their own compromise, a national interest rate cap on loans, as one solution to reach agreement. But that was unpalatable to most of the financial services industry, lobbyists said.
After his amendment was rejected, Meeks’ office issued a “dear colleague” letter early Feb. 14 asking for Democratic support for the bill. The letter pushed back on the concern that H.R. 3299 opens a backdoor for payday lenders to work with banks to get around state usury caps.
“Regulations and legal guidance that currently make it difficult for banks to provide short-term, high-interest rate credit — or to partner with such lenders — would remain law,” Meeks wrote. It also noted that during the Obama administration, both the U.S. Solicitor General and the Office of the Comptroller of the Currency, which regulates national banks, said the Second Circuit’s analysis in Madden was incorrect. Separately, House Majority Whip Rep. Steve Scalise (R-La.) issued his own letter asking Republicans to support the legislation.
But Meeks had to contend with an opposing dear colleague letter from House Financial Services Committee Ranking Member Maxine Waters’ office (D-Calif.) urging lawmakers to vote against H.R. 3299. Waters’ letter echoed consumer groups’ fears that the bill was overly broad and could lead to predatory lending.
“Marketplace lenders, like fintech companies, which can be an important source of innovation that Democrats support, are being used as a front for the real harm this bill would do,” Waters said.
Online lenders are eager to distance themselves from payday lenders.
Companies like Kabbage and Lending Club say they’re filling a void where traditional financial institutions fear to tread. By offering small-business loans up to $250,000 and $300,000, respectively, online lenders say they serve customers seen as too small or risky by traditional banks. Other companies, such as Prosper, present themselves as alternatives to payday lenders by offering better loan terms to consumers.
A 2017 study from the Federal Reserve Banks of Chicago and Philadelphia said online lenders are filling credit gaps left by traditional banks.
The political narrative of depicting the “Madden fix” bills as giveaways to the payday lending industry ultimately ends up doing a disservice to the consumers and small businesses they serve, marketplace lenders have said.
They also say the Madden decision is having real impacts on consumers and the way they conduct business. The ability to sell debt to non-bank entities in the secondary market helps banks hedge risk, maintain liquidity, and preserve their balance-sheet capacity, according to the Marketplace Lenders Association, which represents online lenders.
Banks are reacting to the uncertainty wrought by the Madden decision in a number of ways. Many, like WebBank, a Utah-chartered bank that partners with online lenders like Lending Club and Prosper, are maintaining an economic interest in the loans after they’re sold.
Others are going further. Cross River Bank, a small New Jersey-based bank with a nationwide network of fintech partners, told Bloomberg Law it’s holding loans issued in the Second Circuit states — New York, Connecticut, and Vermont — on its own balance sheet, while those in other states are still sold on the secondary market.
“There was no issue of valid-when-made doctrine not being respected” when the decision came out, Cross River Bank CEO Gilles Gade told Bloomberg Law.
Gade said the bank would like to see the bill become law, “because at the end of the day, the consumers are really getting hurt,” Gade said.
Research has found that banks have tightened credit in Connecticut, New York, and Vermont. Borrowers in those states with credit scores below 625 have seen a 52 percent reduction in credit offers after the ruling, according to a study conducted by three law school professors.
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