OCC 'true lender' rule is wrong path to small-dollar lending by banks

Research shows that payday and similar loans damage millions of Americans’ financial health every year. The Pew Charitable Trusts found that the average payday loan borrower has $375 in outstanding borrowings five months of the year — and pays $520 in fees alone for that credit. The Consumer Financial Protection Bureau has jurisdiction over these loans. By all means, the bureau should immediately reinstate its 2017 payday lending rule, which before being rescinded in 2020 provided necessary consumer safeguards for single-payment loans without restricting installment loans or lines of credit.

But bank regulators such as the Office of the Comptroller of the Currency make decisions that are just as important as anything the CFPB could do in determining the financial fate of millions of households that have no margin for error.

Banks are an obvious source of small-dollar credit. Every one of the 12 million Americans who use payday loans each year has a checking account, which is one of two requirements — along with earning income — for taking out a payday loan. But if banks chose to have a more direct impact by making loans to their checking-account customers, the advantages would be numerous. A bank has an existing relationship with the customer; has no customer acquisition costs; can spread its overhead costs across a full suite of products; can borrow money at a much lower rate than payday lenders do; can use the customer’s cash flow to automate an assessment of the customer’s ability to repay; and can deduct payments only when there is a sufficient balance.

Banks faced too much regulatory uncertainty to make small-dollar loans on a large scale until May 2020, when they received clear joint guidance from the OCC, Federal Reserve, Federal Deposit Insurance Corp., and National Credit Union Administration. That guidance was compatible with the CFPB’s 2017 payday lending rule, which encouraged loans to be repayable in installments with terms of more than 45 days. This meant that banks could now offer installment loans and lines of credit to their customers who had previously been using payday and other high-cost loans. Two of the country’s five largest banks — U.S. Bank and Bank of America — are now offering loans consistent with that guidance.

Problem solved? Not exactly, because just as banks can offer consumer loans at a much lower cost than payday lenders, they can also help payday lenders evade state laws that protect consumers. In fact, a small number of banks are now originating loans for payday lenders that would otherwise be illegal under the payday lender’s state’s laws. The banks, which under their charters are exempt from such laws, make the loans and sell them to payday lenders that in turn market, service and absorb any losses from the loans. The arrangement allows companies to charge more than the state laws allow.

Although these arrangements aren’t widespread, they’ve increased in the past few years. And a new OCC regulation could make this problem much worse by declaring that the bank should always be considered the “true lender” if it originates or funds a loan, even if that loan is quickly sold to a high-cost lender. This regulation does nothing to aid a bank in serving its own customers or enlisting technology providers; instead, it strengthens the hand of high-cost lenders who use bank partners as a rationale for ignoring state laws.

Regulators may have hoped that bank partnerships with payday lenders would lead to lower prices for consumers, but experience shows that the result has instead been lending on terms so expensive that it’s often illegal under state laws. For example, following a 2018 bipartisan reform in Ohio, a few banks have partnered with payday lenders that are unlicensed in Ohio to issue loans at prices nearly double those charged by state-licensed payday lenders. These loans are purportedly exempt from state laws because they are originated by banks — the “true lender” — before being transferred to high-cost lenders, and they have been the subject of legal disputes. The OCC’s rule would have the effect of encouraging these nominal partnerships, the primary purpose of which is avoiding state laws.

A better, safer and much less expensive solution would be for banks to issue affordable installment loans and lines of credit to their existing customers. They can engage financial technology companies to help them automate the underwriting and lending process without selling the loans to payday lenders.

There’s a wrong way and a right way for banks to get involved in small-dollar lending. The OCC got it right in its joint May 2020 guidance with the FDIC, Fed and NCUA, creating a strong foundation for promoting small installment loans and lines of credit that banks issue to their checking-account customers. These loans and lines of credit could save millions of borrowers billions of dollars annually. The OCC’s “true lender” rule, instead, sets up borrowers for failure. It has the effect of raising prices rather than lowering them, undermining hard-won state consumer protections.