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Biden regulators may clamp down on high-cost digital lenders

Digital lenders that partner with banks to offer consumers high-cost loans may be at risk of a crackdown under President Joe Biden's administration.

Those lenders say they are a vital source of emergency loans for vulnerable consumers, whose low credit scores typically shut them out of traditional forms of credit. That service comes with a higher price tag, with annual percentage rates sometimes reaching up to 180%, which lenders say compensates for increased default risks.

Critics say the high interest rates make the loans predatory, putting consumers at risk of being unable to pay back loans and getting trapped in debt cycles. Borrowers are more likely to be people of color, given that the nation's credit reporting systems disproportionately list them as less creditworthy, consumer advocates say.

Regulators in some states have also taken issue with the practice, suing lenders under the premise that they are violating their states' interest rate caps. Many states have capped the maximum APR on a $2,000 two-year installment loan at 36% or less. But digital lenders can surpass those rate caps by partnering with federally regulated banks, which are generally not subject to state rate caps under longstanding federal law.

Take Nebraska as an example. Nonbanks would generally be subject to Nebraska's APR cap of 30%, including fees, on installment loans. But by partnering with banks elsewhere, digital lenders can charge rates far above that. Enova International Inc.'s NetCredit charges as much as 99.99% in Nebraska, while Elevate Credit Inc.'s Rise loans carry APRs as high as 149%, and Applied Data Finance LLC's Personify charges as much as 179.99%

"180% APR loans in the thousands of dollars are not going to help people. That is predatory lending," said Lauren Saunders, who tracks the partnerships for the National Consumer Law Center.

The Online Lenders Alliance, a trade group that represents the industry, says the partnerships help give banks the technology needed to offer credit to populations that often struggle to get traditional loans.

"We are hopeful that policymakers will focus on the facts rather than the politically charged rhetoric from some activists," Andrew Duke, the group's executive director, said in a statement. "If they do, we feel confident that they will not put consumers at risk by eliminating financial options for populations who need them."

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'Four Horsemen of the Apocalypse'

Whether and how the Biden administration may act to limit the high-cost partnerships remains uncertain. But partnerships between banks and financial technology companies charging APRs above 36% may come up against their own "Four Horsemen of the Apocalypse," said Isaac Boltansky, director of policy research at Compass Point Research & Trading.

Three of those horsemen are more lawsuits from state regulators, scrutiny from congressional Democrats and new leadership at the Consumer Financial Protection Bureau. The fourth is Biden's eventual picks to head the Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency, where new leaders could take action to limit the partnerships.

The partnerships have largely occurred at a few FDIC-supervised institutions. FDIC Chair Jelena McWilliams, whose term ends in 2023, said at an April 19 conference that regulators should not "automatically shut off" credit options for consumers. Digital lenders will exist no matter what, and the partnerships bring those lenders and their algorithms under more regulatory scrutiny by letting FDIC bank supervisors examine them, she said.

"Let's not just close the gates," McWilliams said. "Let's bring them in. Let's regulate them appropriately."

OCC acting Comptroller Blake Paulson also addressed bank-fintech partnerships in a letter to top lawmakers seen by S&P Global Market Intelligence. His letter sought to "dispel misperceptions" of the OCC's "true lender" rule, which the agency finalized last year to reduce legal uncertainty for the partnerships. Democrats have slammed the OCC rule over concerns that its standards are too easy and will encourage more partnerships, but Paulson wrote that banks will remain accountable for each loan and that the OCC "will not hesitate to use" its powers to crack down on any wrongdoing.

One OCC-regulated institution, Stride Bank NA, has worked with the fintech company CURO Group Holdings Corp. on a Verge Credit product that offered high-cost loans. But the partnership appears to be on pause. Verge Credit's website says it "is not accepting loan applications at this time."

CURO and Stride Bank did not respond to requests for comment.

Lenders push back

Opportunity Financial LLC, or OppFi, is among the digital lenders making high-cost loans, although CEO Jared Kaplan said the company's first step with applicants is trying to find sub-36% loan options elsewhere. Kaplan said OppFi's goal is to "rebuild financial health and ultimately graduate [borrowers] back to the mainstream" of credit. OppFi lends in partnership with FinWise Bank and First Electronic Bank, with typical loans charging APRs of 160%.

Asked about the landscape for policy changes, Kaplan said the "majority of decision-makers in D.C. recognize the dearth" of credit options available for nonprime borrowers. Those policymakers are committed to improving access by regulating products "rather than price controls," Kaplan said, noting that his company has backed tougher regulations from the CFPB on small-dollar lending.

A spokesperson for Enova, which offers loans with Republic Bank & Trust Co., said the partnerships help smaller banks serve customers "who need small personal loans to avoid bounced checks and late fees on bills or to pay for needed repairs." The company charges APRs as high as 99.99% in states with rate caps of 36% or less.

Other digital lenders include Elevate, whose Rise loans charge APRs of up to 149% in those states; and Personify, which charges APRs up to 179.99% for installment loans.

Elevate declined to comment. Personify did not respond to requests for comment.

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Legal battles continue

State regulators are continuing to battle those arrangements in court. D.C. Attorney General Karl Racine, for example, recently sued OppFi for "illegally lending money to vulnerable consumers at interest rates far above the District's limit" of 24% APR on loans.

In a statement, OppFi said it "intends to vigorously defend itself against these baseless allegations" and that long-standing federal law gives its partner banks the right to preempt local rate caps.

However, critics say banks are merely passive actors in the partnerships and that OppFi and other digital companies are the "true lenders" on the loans. They say fintech companies do the bulk of the work on the loans — from marketing to running algorithms that help determine interest rates — and that they should therefore be subject to local rate caps.

Kent Landvatter, president and CEO of Utah-based FinWise Bank, pushed back against perceptions that his bank is a "passive, sit-back-in-the-rocking-chair" partner and said over a third of his staff is devoted to overseeing compliance with consumer protections.

"We look very carefully at [a digital lender's] structure and how they manage compliance," Landvatter said. "Because in essence, they are an extension of the bank. Their screw-ups are our screw-ups."

Banks getting in the mix

The digital lenders may soon face more competition from banks themselves.

Federal bank regulators are now encouraging banks to consider ways of offering small-dollar loans, releasing an interagency statement in May 2020 that nudged banks to do so responsibly. Two of the country's biggest banks have since launched programs for their existing checking account customers.

Bank of America Corp. has launched a Balance Assist option for checking account customers, who can borrow up to $500 for a $5 fee. The effective APR ranges from 5.99% to 29.76% depending on the loan amount, the bank says.

U.S. Bancorp also launched a Simple Loan option for its existing depositors. The program lets customers borrow up to $1,000, charging either $12 or $15 for every $100 borrowed, depending on the repayment option a customer selects. A sample $400 loan on U.S. Bank's website says it could carry an APR of 70.65%.

Kaplan, the OppFi CEO, said he would welcome the competition since "it would be a huge win for consumers" and accelerate ongoing efforts to lower interest costs.

But Kristin Johnson, a law professor at Emory University, cautioned against automatically assuming competition will be beneficial. Without adequate consumer protections, lenders can engage in a "race to the bottom" on loan standards and ultimately expose the entire financial system to risk.

"That can ultimately destabilize the broader financial system," Johnson said, pointing to the 2007-09 crisis as an example. "I fear that there is too little emphasis on that connection."