When differences emerge between the activities of state banks and national banks in the U.S. dual banking system, the root cause typically is a difference between state and federal law.1 But this is not the case when it comes to differences between state banks’ and national banks’ willingness to engage in “bank model lending” relationships with nonbank lenders. This disparity is instead attributable to a difference in supervisory policy between two federal agencies — the OCC and the FDIC. This difference was recently brought to the forefront in the June 13 testimony of OCC Comptroller Joseph Otting before the House Financial Services Subcommittee and in the OCC’s May 23 publication of “Bulletin 2018-14 (Core Lending Principles for Short-Term, Small-Dollar Installment Lending.”
Regulators’ View of Bank Model Lending
National banks and insured state banks have essentially the same ability to export their home state’s interest rates. In either case, this ability arises under federal law, as opposed to state law. However, the applicable federal statutes are not the same: For national banks, section 85 of the National Bank Act (NBA) governs, and, for state banks, section 27 of the Federal Deposit Insurance Act (FDIA) applies.2 The OCC and the FDIC, as well as most federal courts, interpret these laws in pari materia (i.e., substantially the same). However, the OCC has long disfavored bank model lending for national banks, whereas the FDIC has issued draft guidance endorsing this type of lending as a general business activity.
The OCC’s adverse view of bank model lending dates back to 2002, when the OCC issued a consent order prohibiting payday lender ACE Cash Express, Inc. from “entering into any kind of written or oral agreement to provide any services, including payday lending, to any national bank or its subsidiaries without the prior approval of the OCC.” Although this order only covered ACE Cash, it had the effect of virtually eliminating bank model lending by national banks.
When the OCC lifted the ACE Cash order in February 2018, many in the industry saw the action as a harbinger of a shift in policy. To this end, eight months earlier, in June 2017, the OCC issued “Bulletin 2017-21 (Frequently Asked Questions to Supplement Bulletin 2013-29; Third-Party Relationships: Risk Management Guidance,” which outlines the OCC’s supervisory expectations for controls a national bank should have in place before entering into any relationship with a nonbank lender. Bulletin 2017-21 is silent regarding bank model lending. In recent congressional testimony, however, Comptroller Otting responded as follows to a question about lending relationships between national banks and nonbanks:
When you say bad or sham or people renting the charter, we’ve generally looked at where financial institutions . . . [are] using their underwriting and putting those loans on their books. . . I think where most of the activity in the future will be [is where banks] . . . use those people as vendors, where they have a great portal or a great way [for the bank] to reach customers.3
Comptroller Otting later added, “We’ll be happy to come out with some thoughts on what is a true vendor relationship.”4
In addition, in Bulletin 2018-14, the OCC asserted 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).” This statement leaves open the possibility that bank model lending might not be viewed unfavorably by OCC examiners, depending on the circumstances of the relationship.
The FDIC takes a markedly different view of bank model lending. In its June 2016 draft “Third Party Lending Examination Guidance,” which remains pending nearly two years after it was published for public comment, the FDIC addressed bank model lending in the context of state-chartered “institutions originating loans for third parties in volumes that exceed the size of the institution’s balance sheet by many multiples or relationships with large, or multiple, widely-dispersed third parties.” This scenario reflects the fact that a number of state banks engage in bank model lending as their primary business activity. The FDIC’s draft guidance advises state banks that “indemnification, representations, warranties, and recourse terms [of the bank’s contract with the nonbank] should limit the institution’s exposure and should not expose the institution to substantial risk,” and bank legal counsel is advised to review the bank model lending relationship to identify “any potential recourse” to the bank.5
Increasingly, bank model lending programs are being targeted in “true lender” lawsuits, in which a state attorney general or private litigant alleges that the lack of meaningful risk taking on the part of the bank proves the program is a sham, “rent a charter” scheme. These lawsuits are based on judge-made law and have no statutory basis in either the NBA or the FDIA. Given the close similarity in the interest rate export rights afforded under those statutes, formal guidance or regulatory action supporting bank model lending from either the OCC or the FDIC would be extremely helpful to nonbank online lenders and the banks with which they partner.
- Neither the current stance of the FDIC, which is unsettled and advises state banks to avoid the legal and economic risks associated with bank model lending, nor that of the OCC, which is ambiguous and seems to disfavor such lending, provides adequate assistance to banks and their nonbank partners. In addition, although OCC guidance generally encourages relationships between national banks and nonbanks, the guidance presumes that the bank will be using the services of the nonbank to provide ancillary support to the bank’s lending activities and is silent regarding bank model lending.
- Because of the close relationship between section 85 of the NBA and section 27 of the FDIA, formal agency guidance or regulatory action favoring bank model lending from either the OCC or the FDIC would have a strong positive impact on all banks that are engaged, or interested in becoming engaged, in bank model lending, irrespective of form of charter.
- The lack of definitive formal guidance from the FDIC concerning bank model lending is perpetuating legal uncertainty for state banks that participate in this activity. To this end, the FDIC’s draft guidance acknowledges that “engaging in third-party lending arrangements may . . . enable institutions to lower costs of delivering credit products and to achieve strategic or profitability goals.”