Congressional Repeal Highlights Issues With Risky Bank Lending Partnerships

Following action by bipartisan majorities in the House and Senate, President Joe Biden signed a measure into law June 30 that rescinds the “true lender” rule, which the Office of the Comptroller of the Currency (OCC) finalized in October. Supporters of the rule had argued that it would boost competition and expand access to credit, but in fact it allowed payday lenders to issue loans with bank sponsors that often had higher prices and fewer protections than those already available under state laws.

The rule was rolled back using the Congressional Review Act, which gives lawmakers the ability to rescind recently enacted regulations. The House voted 218-210 to rescind the rule on June 24, and the Senate voted 52-47 on May 11.

The rule sanctioned partnerships in which federally chartered banks would originate loans on behalf of high-cost lenders to customers who had no other relationships with the banks; such loans would otherwise be prohibited by state laws. The loans could then be quickly sold to nonbank lenders. These partnerships are known as “rent-a-bank” or “rent-a-charter” arrangements.

The rule declared that the bank should always be considered the true lender, essentially shielding the partnerships from legal and regulatory scrutiny, even when they served little purpose other than to circumvent state laws. But this approach poses serious risk to borrowers and the banking system.

When the OCC proposed its “true lender” rule last summer, Pew warned that it could lead to the re-emergence of rent-a-bank practices, which could facilitate high-risk loans and compromise the progress made in efforts to create safer alternatives to high-cost payday loans.

The votes show that lawmakers share these concerns. Further, on the day of the Senate action, the White House issued a statement supporting repeal, saying the rule “undermines state consumer protection laws and would allow the proliferation of predatory lending by unregulated payday lenders using, among other vehicles, ‘rent-a-bank’ schemes to funnel high-interest, predatory loans through national banks to evade state interest rate caps.”

The repeal is a strong step forward. Now bank regulators must act to curtail other rent-a-bank arrangements, most of which involve institutions supervised by the Federal Deposit Insurance Corp. (FDIC), not the OCC. Despite banks’ limited knowledge of the borrowers, limited underwriting, and the loans’ onerous terms, the FDIC has not put a stop to this dangerous lending.

In at least seven states—Colorado, Maine, New Mexico, Ohio, Oregon, Virginia, and Washington—rent-a-bank loans cost borrowers more than loans issued by state-licensed payday lenders. In these instances, the partnerships raise the cost of credit to vulnerable consumers who usually have no ongoing relationship with the bank that issued the loan.  

Although supporters of these arrangements argue that they improve access to credit, a far better and less risky path to safe small-dollar credit is available, unaffected by the true lender rule repeal. Joint guidance from the FDIC, OCC, Federal Reserve, and National Credit Union Administration issued in May 2020 gave banks the regulatory clarity needed to offer to their customers safe, affordable small-installment loans or lines of credit that are subject to federal oversight.

The regulators also said banks could use third-party expertise and technology to help make such lending cost-effective. For example, a nonbank partner can provide the technology to increase the speed and reduce the cost of underwriting and originating loans to a bank’s checking account customers. Federal regulators must prohibit  the rent-a-bank partnerships immediately and in a way that fosters more beneficial bank small-dollar lending—with help from technology providers if needed.

Two of the country’s five largest banks, U.S. Bank and Bank of America, already offer small installment loans consistent with the 2020 guidance, and momentum is growing for more banks to follow suit. Federal regulators can foster this kind of innovation by continuing to encourage banks to make safe small-installment loans available to their customers.

If banks chose to have a more direct impact by making safe and affordable loans to their checking account customers, they would have numerous advantages compared with nonbank lenders that would help  them offer loans at much lower prices than these competitors. They have  existing relationships with their customers; have no customer acquisition costs; can spread overhead costs across a full suite of products; can borrow money at much lower rates than payday lenders; can use customers’ cash flow to automate an assessment of their  ability to repay; and can deduct payments only when there is a sufficient balance.

Because each of the 12 million Americans who use payday loans each year has a checking account, consumers could save billions of dollars a year and be protected by the banking system’s federal regulation if banks chose to serve these customers instead of handing them over to payday lenders.

Nick Bourke is the director and Alex Horowitz is a senior research officer with The Pew Charitable Trusts’ consumer finance project.