OAKLAND, Calif. (CN) — Seeking to stop the cycle of unsophisticated borrowers getting trapped in a recurring cycle of debt, multiple states have imposed regulations on payday lenders in recent years — regulations that will no longer apply to some lenders under a new Trump administration rule.
California, Illinois and New York sued the Office of the Comptroller of Currency, a bureau of the U.S. Treasury Department, Wednesday over a new rule that makes it easier for lenders to skirt state laws that cap interest rates for payday loans.
The rule finalized on June 2 makes lenders who partner with federally regulated banks exempt from state interest rate caps on loans.
“The OCC creates loopholes that allow predatory lenders to bypass our laws,” California Attorney General Xavier Becerra said in a statement Wednesday. “Particularly during this period of economic crisis, the Trump administration should fight to stop these bad actors, not enable them.”
The states are challenging the new rule on several grounds. They claim OCC lacks the power to enact the rule, that the rule violates procedures created by Congress after the last financial crisis, that it ignores the potential for regulatory evasion of state laws and that OCC fails to provide evidence supporting its change in policy.
The states say the rule contradicts laws enacted by Congress after the 2007-2008 financial crisis, specifically the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which declares in three separate subsections that federal banking laws do not prevent states from regulating subsidiaries, affiliates or agents of national banks.
California tightened its payday lending law last year, setting a 36% interest rate cap for payday loans. Illinois passed laws in 2005 and 2010, capping interest for loans at $15.50 per $100 and 36% for certain loans. New York state has prohibited high interest loan rates for centuries, capping rates for most loans at 25%.
The states say the Trump administration rule will facilitate a “rent-a-bank scheme” in which payday lenders partner with banks, which “act as a mere pass-through for loans that, in substance, are issued by non-bank lenders.” These partnerships allow lenders to evade state laws that do not apply to federally regulated banks.
California notes that several lenders were already scheming to sidestep its consumer protection laws before the OCC finalized its rule. It cites comments by an executive from the company Elevate, doing business in California as Rise, who stated on a July 2019 earnings call as California sought to tighten its laws that it expected “to be able to continue to serve California consumers via bank sponsors that are not subject to the same proposed state rate limitations.”
The states complain that the OCC lacks the power to unilaterally change the law and make third parties that partner with banks exempt from state law. The states cite a 2014 Second Circuit ruling, Madden v. Midland Funding LLC, which found a debt collector trying to recover a debt at 27% interest from a borrower was subject to state laws, even though the debt originally came from a national bank.
The OCC says that ruling conflicts with a common law principle called “valid-when-made” which exempts loan buyers from state laws if the debt originated from a national bank. The OCC claims that legal principle gives it the authority to enact the new rule.
According to the states, the Frank-Dodd Act lays out prerequisites that federal agencies must meet before they can finalize a rule that preempts state consumer protection laws. It requires the federal agency to determine on a case-by-case basis if a state law significantly interferes with the national bank’s exercise of its powers, consult the Consumer Financial Protection Bureau and have “substantial evidence” to support a finding of preemption.
“In its present rulemaking, the OCC has failed to abide by any of these procedural and substantive requirements,” the 62-page lawsuit states.
The states further insist that the OCC has failed to justify its dramatic change in position from as recently as May 2018 when it issued a bulletin stating that it “views unfavorably an entity that partners with a bank with the sole goal of evading a lower interest rate established under the law of the entity’s licensing state(s).” The bulletin was rescinded in May 2020.
OCC spokesman Bryan Hubbard said the rule was intended to provide “legal certainty” for lenders that obtain and transfer loans from federally regulated banks.
“The rule protects the sanctity of legal contracts and provides the legal certainty to support the orderly function of markets and availability of credit,” Hubbard said by email. “We are confident in our authority to issue a rule on this matter and look forward to defending that authority.”
The states say the rule undermines their consumer protection laws. They seek a court order invalidating the agency’s action.
The OCC rule follows another rule finalized by the Consumer Financial Protection Bureau on July 7 that rescinds an Obama-era regulation requiring payday lenders to assess whether borrowers taking out loans can afford to pay them back.