States sue FDIC over 'rent-a-bank' partnerships

WASHINGTON — Seven states and the District of Columbia have sued the Federal Deposit Insurance Corp. over a rule designed to address legal ambiguity in the secondary loan market, arguing the regulation would allow predatory lenders to skirt state interest rate caps.

The FDIC is the second federal bank regulator to be sued by states for finalizing a rule in June reacting in part to the Madden v. Midland Funding decision, in which a federal judge ruled that the legal principle of valid-when-made in the secondary loan market did not apply to parterships between banks and nonbanks. The Office of the Comptroller of the Currency was sued over its own ‘Madden’ fix by a smaller group of states in July.

In the latest lawsuit — similar in structure to the one filed against the OCC — attorneys general from California, Illinois, Massachusetts, Minnesota, New Jersey, New York, North Carolina, and D.C. allege the core of the rulemaking “is beyond the FDIC’s power to issue, is contrary to statute, and would facilitate predatory lending through sham ‘rent-a-bank’ partnerships designed to evade state law.” The attorneys general of California, Illinois and New York were the plaintiffs in the OCC suit.

The lawsuit claims the FDIC violated the Administrative Procedure Act when it issued its rule for failing “to follow the procedures set forth by Congress, ignored the potential for regulatory evasion, and failed to explain its rejection of evidence contrary to its proposal.”

The FDIC did not comment on the lawsuit.

Under federal law, banks have been allowed for decades to export interest rates across state lines when purchasing or selling loans on the secondary market. But consumer advocates have warned in recent years about the rise of so-called rent-a-bank partnerships, where expensive marketplace lenders partner with banks for the sole purpose of bypassing state interest rate caps to sell predatory products.

Both the FDIC and OCC have argued they are well within their statutory authority to issue a rule that affirms valid-when-made for nonbank partnerships.

When the FDIC finalized its rule in June, it cited the Depository Institutions Deregulation and Monetary Control Act, passed by Congress in 1980, that allowed state-chartered banks to maintain the interest of loans transferred across state lines, so long as the interest rate was legal in the originator’s state. But in their lawsuit, the states argued that that particular provision — in Section 27 of the Federal Deposit Insurance Act — applies only to FDIC-regulated banks.

“A number of motives explain this special treatment,” the attorneys general wrote in their complaint, but "none of these motives apply to nonbanks, and for that reason, Congress carefully selected the language of [the statute] to apply exclusively to FDIC Banks.”