As FinTechs gain ground within financial services, as banks partner with these digital-first upstarts to broaden their offerings, several business practices are coming under scrutiny and under fire.
To that end, a coalition of advocacy groups is pushing regulators in the U.S. to investigate the practice that is known as “rent a bank.”
Read more: Advocacy Groups Call on Regulators to Ban High-Interest Rate FinTech Loans
In broad terms, the practice is one where rent-a-bank activities give non-bank lenders leeway to charge rates as high as 225% — even in states where the cap on rates may be around 36%, and can be less than that.
The Rent-a-Bank Mechanics
As for the mechanics of the partnerships, a non-bank lender that wants to sidestep interest rate caps links up with a bank to originate the loans. The national banks, with Federal Deposit Insurance Corporation (FDIC) insurance in place, are exempt from the state laws that govern interest rate caps. After the loan is processed and extended to the consumer by the bank, the bank sells the loan receivables back to the non-bank, which in turn keeps the loans on its books. The consumer’s payments are collected by the lender (not the bank).
The “workaround” — where the interest rates can be astronomical — works because the FDIC-insured commercial bank, with activities across several states, is not burdened with the dilemma of addressing and resolving the differences in state-by-state usury laws because it only needs to observe the usury limits of the state where it is located (and not anywhere else). If that domicile state does not in fact have caps in place, the rates levied on loans can reach into the triple-digit percentage points.
The business model has been around for a while but has been coming under more intense regulatory pressure as high-tech operators are able to branch out more fully into lending activities.
Almost exactly two years ago, at a hearing before the House Financial Services Committee, representatives from several consumer groups said rent-a-bank schemes harm consumers.
See more: Lawmakers Grill Consumer Groups on ‘Rent-a-Bank’ Schemes
Lauren Saunders, who serves as associate director of the National Consumer Law Center, said state-regulated lenders “lauder their loans up to 160% annual percentage rates through banks in order to evade state interest rate caps. These schemes are spreading across the country and are starting to explode.”
The rent-a-bank practice, as a whole, is a relatively small one as measured against the financial services landscape. In an interview with NPR, Saunders noted that the National Consumer Law Center has identified through its own watch list lenders and banks that have used rent-a-bank models to loan $1 billion through the last several years.
Now, the FDIC is being prompted by the advocacy group to prevent “banks from fronting for predatory lenders,” per a letter to the regulator. The letter comes as the FDIC’s top leadership is changing. Martin Gruenberg, a Democrat, is taking over as acting chair, succeeding Jelena McWilliams, who had been appointed by former President Donald Trump.
Politically speaking, the time may be ripe for rent-a-bank models to be severely curtailed, and they may, in fact, be regulated out of existence.
About 53% of consumers in the U.S. live paycheck to paycheck, which in turn means that they struggle to meet monthly expenses. Drill down a bit, and that means that at least some of these consumers may be more predisposed to tap loans (predatory loans among them) in an effort to smooth cash flow bumps.
Read more:53% of Upper-Income Americans Live Paycheck to Paycheck