April 23, 2020 |
In two recent joint statements, the federal banking agencies have encouraged banks to make short-term loans to consumers and small businesses impacted by the COVID-19 crisis. In their March 30 “Joint Statement Encouraging Responsible Small-Dollar Lending in Response to COVID-19,” the agencies noted that “the important role that responsibly offered small-dollar loans can play in helping customers meet their needs for credit due to temporary cash-flow imbalances, unexpected expenses, or income short-falls during periods of economic stress or disaster recoveries.” This statement closely followed the agencies’ March 19 “Joint Statement on CRA Consideration for Activities in Response to COVID-19,” which listed “expanding the availability of other short-term, unsecured credit products for creditworthy borrowers” as an activity that will be viewed favorably in evaluating a bank’s responsiveness to the needs of “low- and moderate-income individuals, small businesses, and small farms affected by COVID-19.” In light of these statements, banks would be well-advised to explore opportunities for relationships with fintech lenders as a means of serving consumers and small businesses whose economic resources are being temporarily stressed by the ongoing crisis.
Both the OCC and the FDIC have publicly cautioned banks against entering into relationships with nonbank lenders where the sole motivation is to enable the nonbank party to evade state usury laws.1 The possibility that a regulator or court might impute such an improper intent is an inherent risk in any “bank sponsor” lending program, whereby a bank makes loans and then sells those loans, or related loan receivables, to a nonbank lender that provides loan origination and account servicing to the program. However, the risk that the nonbank in such a relationship could be deemed the “true lender” is counterbalanced by the fact that banks are being asked to increase forms of lending that fintech lenders specialize in, as well as by recent OCC guidance clarifying the expansive extent to which national banks may rely on third-party services to support lending and other activities. Furthermore, as the FDIC explained in a Winter 2015 Supervisory Insights article titled “Marketplace Lending” and its July 2016 proposed “Examination Guidance for Third-Party Lending,” banks may engage in a wide variety of relationships with fintech lenders, most of which pose no implications for state usury laws.
In addition to discussing bank sponsor loan programs, the FDIC’s “Marketplace Lending” article highlights funding relationships between insured banks and with fintech lenders, in which the fintech makes and services the subject loans. The same article discusses relationships in which an insured bank originates loans for itself using a third-party underwriting platform, which is an increasingly common type of relationship between banks and fintechs. The FDIC’s “Examination Guidance for Third-Party Lending,” in turn, additionally highlights relationships in which an insured bank relies on a third party, or possibly numerous third parties, to generate loan volume for the bank by acting as its authorized agent. Regardless of the nature of the relationship, both bodies of guidance emphasize the need for the bank to adhere to the supervisory expectations set forth in the FDIC’s general “Guidance for Managing Third-Party Risk,” which describes effective third-party oversight as resting on four foundational elements: (1) risk assessment, (2) due diligence in selecting a third party, (3) contract structuring and review, and (4) oversight.
The OCC has been very active over the past several years in facilitating relationships between fintechs and national banks, including though its published guidance. The most recent such guidance, OCC Bulletin 2020-10, which was issued on March 5, further expanded on and replaced OCC Bulletin 2017-21 (Frequently Asked Questions to Supplement Bulletin 2013-29). As in the case of the earlier bulletin, many of the new and repeated FAQs stated in Bulletin 2020-10 address matters of particular relevance to fintech relationships, including risk management expectations for the use of third-party underwriting models by national banks.
• Establishing relationships with fintechs, or expanding the number and scope of such relationships for those banks that are already utilizing fintech-provided services, offers a ready means for meeting the credit needs of the millions of consumers and small businesses that are being adversely affected by the COVID-19 crisis. In this regard, many fintechs specialize in lending to lower-income consumers who historically have been underserved by banks. As a result, these fintechs possess particular expertise in making small-dollar, short-term loans to these consumers, and are adept at identifying borrowers with poor or limited credit who are nonetheless able to repay.
• Banks should not be dissuaded from exploring potentially highly productive relationships with fintechs by the legal issues associated with bank sponsor lending programs. Engaging in this type of lending with the objective of heeding the federal bank agencies’ call for increased small-dollar, short-term lending is a legitimate purpose that has nothing to do with evading state usury laws. In any event, as both the FDIC and OCC guidance highlights, there are myriad ways for banks and fintechs to work together besides bank sponsor lending.
• At the conclusion of their “Joint Statement Encouraging Responsible Small-Dollar Lending in Response to COVID-19,” the bank agencies note that they “are working on future guidance and lending principles for responsible small-dollar loans to facilitate the ability of financial institutions to more effectively meet the ongoing credit needs of their communities and customers.” While this guidance and principles are being developed, fintech companies stand ready to assist banks in dealing with the existing economic crisis by helping them make small-dollar loans to borrowers whose creditworthiness cannot be reliably determined.
1 OCC Bulletin 2018-14 (Installment Lending: Core Lending Principles for Short-Term, Small-Dollar Installment Lending); FDIC November 19, 2019 press release regarding proposed rule clarifying federal interest rate authority.
Compliments of Pepper Hamilton – a member of the EACCNY.