Small-Dollar Lending: State AGs Offer FDIC Advice, CA DBO Takes Action

Financial Services Law

Small-dollar lending made headlines recently, with a group of 14 attorneys general responding to the Federal Deposit Insurance Corporation’s (FDIC) request for information (RFI) on the subject and a new California Department of Business Oversight (DBO) enforcement action.

The DBO’s $900,000 settlement is the fifth action taken in two years as part of the regulator’s crackdown on lender avoidance of interest rate limits on small-dollar consumer loans.

What happened

Last November, the FDIC asked for input on how to encourage its supervised institutions to offer small-dollar credit products that are responsive to customers’ needs and that are underwritten and structured prudently and responsibly.

Led by Attorney General of the District of Columbia Karl A. Racine and Massachusetts Attorney General Maura Healey, a total of 14 attorneys general cautioned state-chartered banks seeking to enter the small-dollar lending sector about legal risks, with an emphasis on the dangers of associating with payday lenders.

Many states have enacted laws to protect consumers from abuses associated with high-cost small-dollar credit offered by fringe lenders, the AGs wrote, typically capping the annual percentage rate (APR) that licensed lenders can charge for small, unsecured loans and prohibiting unlicensed lending. States also place restrictions on the ability to take out multiple loans or rollover credit and outright prohibit certain loans.

In response, nonbank entities such as payday lenders and high-cost installment lenders have attempted to leverage relationships with third parties to overcome state restrictions. The associations began with traditional banks and moved to Native American tribes, the AGs said, although payday lenders are once again returning to banks.

“State-chartered banks should be wary of entering into relationships with fringe lenders that are structured to evade state rate caps,” the AGs of California, Colorado, Connecticut, Illinois, Iowa, Maryland, Massachusetts, New Jersey, New York, North Carolina, Oregon, Pennsylvania, Virginia and Washington, D.C., wrote. “We recommend that the FDIC discourage banks from entering into these relationships in any guidance it issues on small-dollar lending.”

The AGs added a second recommendation: discouraging banks from extending small-dollar loans without considering the consumer’s ability to repay. Any guidance on small-dollar lending from the FDIC should include factors banks should consider, such as a consumer’s monthly expenses (recurring debt obligations and necessary living expenses), an ability to repay the entire balance of the proposed loan at the end of the term without re-borrowing and the capacity to absorb an unanticipated financial event (a medical emergency, for example, or loss of income).

“A state-chartered bank that directly or indirectly extends credit that is structured to fail, that lacks economic substance or where there is no reasonable probability of repayment may violate state [unfair and deceptive acts or practices] or state-law unconscionability,” the AGs cautioned.

In other small-dollar lending news, the DBO announced a $900,000 settlement with an entity the regulator said violated the California Financing Law (CFL) by charging some borrowers rates and administrative fees greater than those authorized by state law.

According to the regulator, DBO exams revealed that the lender overcharged interest and administrative fees by steering borrowers into loans of more than $2,500 to allegedly evade the CFL’s interest rate caps, which do not apply to loans in bona fide amounts of $2,500 or more. The lender also advertised “signature loans” of “up to $5,000” without disclosing that the minimum loan amount it offered was $2,501, the DBO said.

The DBO further said the lender overcharged some borrowers by collecting charges twice, allowed borrowers to take out a new loan before an old loan was paid off and, in some instances, deposited borrowers’ checks before the due date specified in the loan agreements without their written authorization.

To settle the charges, the lender must pay $105,000 in costs and penalties and provide approximately $100,000 in refunds for roughly 1,200 consumer loans and another $700,000 in refunds for around 3,000 payday loan transactions.

Over the past two years, the DBO has taken four other similar actions as part of its ongoing effort to investigate the extent to which licensed lenders have, in the DBO’s view, improperly evaded the CFL interest rate limits. One company accused of steering consumers into higher-interest loans (by telling borrowers that loans of less than $2,600 were prohibited by state law) agreed to refund approximately $700,000 to 6,400 borrowers and pay $50,000 in penalties and costs; in another case, a pair of entities provided almost $180,000 in refunds and another $28,000 in penalties and costs for similar state law violations.

Another company paid $160,000 ($77,859 in administrative penalties and $82,140 in refunds) for adding registration fees payable to the state department of motor vehicles to the principal amount of its loans, pushing it over the $2,500 limit so that the lender could increase its interest rates.

“Steering consumers into higher-cost loans to circumvent statutory interest rate caps is abusive,” DBO Commissioner Jan Lynn Owen said in a statement. “Consumers deserve protection and access to lending markets that are fair [and] transparent and comply with the law.”

To read the letter from the AGs to the FDIC, click here.

To read the DBO consent order, click here.

Why it matters

The letter from the coalition of attorneys general and recent actions by the DBO reflect a continued regulatory focus on small-dollar lending and payday lenders, as well as the efforts of state regulators to step in and fill what they perceive as the enforcement void created by the less active Consumer Financial Protection Bureau (CFPB), including in connection with the CFPB reconsidering its small-dollar loan rule.