Ever since the development of a national banking framework in 1863, there has been an understanding of the benefit of a uniform, national banking law. Although the initial rationale behind the National Bank Act (and the subsequent creation of national banks) was driven primarily by the desired adoption of a national currency, many other benefits of a national bank system soon became apparent, including uniform nationwide regulation and supervision of national banks.
The Office of the Comptroller of the Currency was created by the National Bank Act as a department of the U.S. Treasury to be the primary regulator for the national banks. State-chartered banks could no longer issue their own “notes” (i.e., currency), but state banks did not disappear. Rather, state banks became an alternative to the national banks, primarily to take advantage of favorable state laws or lower capital requirements. Bank regulations varied widely from state to state, and still do.
In 2004, the then-Comptroller of the Currency, John Hawke, cited the National Bank Act as the authority to effectively preclude state attorneys general from overseeing national banks. In fact, this was merely a restatement of existing law. The Supreme Court had earlier upheld, in rulings from 1978 and 1996, the right of a national bank to charge interest on loans under the rules of the state of domicile of the bank — even if the borrower were to reside in a state with a lower usury rate ceiling. This concept, referred to colloquially as “rate exportation” is at the heart of the current controversy between many state attorneys general and the OCC.
The ability of a bank to export its home-state rate is well understood and has significant precedent. But the emergence of the fintech “bank partner” model has poured gasoline on what has been a long-smoldering source of antagonism between state and federal regulators. Under the bank partner model, a nonbank loan origination and underwriting company coordinates the extension of credit from a bank to a borrower. The loan is made in accordance with bank underwriting and policy requirements, and after the loan has been extended, the bank sells the loan to the nonbank partner.
Some state attorneys general, consumer banking activists, state banking authorities and others claim that in the bank partner model, the bank that extended the loan is not the “true lender.” They argue that a bank’s interest rate exportation rights reside with the originating bank only and do not survive conveyance of the receivables. Conversely, banks, banking trade associations and the OCC, among others, have pointed out that this interpretation violates the “valid when made” doctrine — that is, if a loan complies with all relevant law when it is made, (i.e., is “valid”), a subsequent transfer of the loan cannot make it unenforceable. Anything that weakens the valid-when-made doctrine serves to impair the liquidity of the national banks. Banks frequently sell loans as part of good balance sheet management.
A dangerous precedent was set in Madden v. Midland Funding, where the U.S. Court of Appeals for the Second Circuit held a nonbank debt collector that purchased charged-off consumer debt from a national bank was not entitled to rely on the bank’s federal preemption of New York usury law. In a different context, but equally troubling, is the U.S. Court of Appeals for the Ninth Circuit’s ruling in Bank of America NA v. Donald M. Lusnak. In Lusnak, the court held that Bank of America needed to pay interest on a mortgage escrow account as prescribed by California law, and that California law was not preempted by federal law since it did not “significantly interfere” with the exercise of national bank powers. Although this position is contrary to the OCC’s preemption standard, the Ninth Circuit stated that the OCC regulations were entitled to “little if any deference.” The U.S. Supreme Court refused to review either of these cases.
Other recent court cases have further magnified the potential harm to national banks threatened by the true lender litigation. In a pending action in Colorado, the state attorney general is claiming that when a loan is securitized, the securitization trust becomes a creditor, hence the true lender. (The attorney general must hold lenders in exceptionally low regard to claim that a passive special-purpose entity is the “true” lender.) The perhaps unintended consequence of this is that a bank that must hold a loan on its balance sheet until it is repaid, with no ability to sell the loan, will be more reluctant to make the loan at all. As willingness to lend decreases, the more marginal borrowers will be the first to suffer.
Although the fintech-bank partner model has been a catalyst for this trend challenging National Bank Act powers and other federal preemption standards, the outcome of these cases may have very broad repercussions. Traditional OCC-chartered national banks are on the strongest footing to maintain preemption and rate exportation rights, but even these banks are at risk of seeing their rights eroded.
The dual (state and national) banking system has served the U.S. very well for a long time. Would consumers really be better off if the states dominate banking regulation, resulting in an untenable 50-state patchwork of laws? Before court decisions turn the banking industry into something akin to the state-regulated insurance industry, Congress should act to clarify the “valid when made” doctrine and reassert the rights conveyed by the National Bank Act.
