Partnerships between traditional banks and fintechs are common, and can help both sides accomplish positive things that they couldn’t do on their own. For example, a traditional bank might partner with a fintech company in order to offer its customers digital wallets.
There’s nothing intrinsically wrong with such deals, but 21st-century technology makes it all too easy to use partnerships to create an end-run around local restrictions. Take payday lending, the pernicious high-rate, short-term loans that too often land customers in a debt trap. Rules against this practice vary widely; payday lending is legal with rates essentially unregulated in 31 states. In the rest, there are caps on legally chargeable interest rates, usually somewhere between 20% and 36%.
But the laws were mostly conceived before Web technology enabled a federally regulated traditional bank in a payday-friendly state to make loans to consumers in more regulated areas, often using a nationally-known fintech as the intermediary. This is “rent-a-bank” lending and some consumer activists say it’s on the rise. In October, the Office of the Comptroller of the Currency (OCC) issued a “true lender” rule that the Center for Responsible Lending says “gives predatory lenders a roadmap to evade state consumer protections.”
That dicy—but not clearly, explicitly outlawed—strategy has recently landed fintech lender OppFi in legal hot water. This month, the Attorney General for the District of Columbia Karl Racine sued OppFi, charging that its partnership with an FDIC-regulated bank in Utah has enabled it to loan money to District residents at a far higher interest rate than its laws permit.
Racine’s case may or may not succeed, but it’s notable because, while the Chicago-based OppFi is not quite a household name, it’s a shooting star in its class. The company’s 2020 revenues were just shy of $300 million and it expects 2021 revenue of more than $400 million—then doubling that by 2023. The projections are plausible: the company made the Inc. 500 list of America’s fastest-growing private companies for four consecutive years and just missed in 2020.
That kind of growth in a hot sector like fintech attracts investors. In February, OppFi merged with a SPAC that is chaired by Joe Moglia, the former CEO of TD Ameritrade. And OppFi is rapidly ramping up its offerings: In December, it introduced Salary Tap, which allows customers to pay off loans through payroll deductions, a program the company expects will grow 200% in coming years. OppFi is also on track to offer a credit card.
Racine’s lawsuit says that in 2018 OppFi developed a partnership with FinWise, a Utah-chartered bank, to offer online loans for amounts between $500 and $4000. Even though, according to the lawsuit, OppFi takes nearly all the risk and most of the profits from its loans, the terms are being set in Utah, where payday loans are essentially unlimited. (FinWise makes a few bucks just passing the loan through.)
Thus, Racine charges that OppFi is a payday lender in disguise:
Despite advertising OppLoans as consumer-friendly products, OppFi’s loans saddle consumers with exorbitant and unfair interest rates of up to 198% that far exceed the permissible interest allowed in the District.
The suit also alleges that OppFi’s marketing is deeply misleading. For example, OppFi advertises that it can help borrowers improve their credit scores but, the suit maintains, because of high default rates, most of the information OppFi passes on to credit bureaus is negative.
Contacted by FIN, an OppFi spokesman said: “OppFi believes that its business practices are unambiguously legal under federal law, and it agrees with federal and other regulators’ rationale for supporting this longstanding policy. As such, OppFi intends to vigorously defend itself against these baseless allegations for which OppFi believes it has good defenses.”
Racine’s suit isn’t OppFi’s only regulatory headache. OppFi acknowledged in a recent regulatory filing that the Consumer Finance Protection Bureau (CFPB) has demanded information about the company’s compliance with the Military Lending Act, which also legally caps the interest rate that lenders can charge.
What’s unusual about this situation is that OppFi is publicly engaged in the question of how to regulate small loans. OppFi CEO Jared Kaplan has argued that the problem isn’t lenders’ greed, it’s math. He asserts that, given high levels of default, if you are lending consumers very small amounts of money—say, a few hundred dollars—you’ve got to charge a three-figure interest rate to break even, as this Federal Reserve chart illustrates:
In words that may come to haunt Kaplan, he asserts:
It’s difficult to call breaking even “predatory.” It’s also important to understand that if a business can’t justify offering a loan product from a dollars-and-cents perspective, the product won’t exist.
That’s certainly true, but the history of rapacious lending suggests that nonexistence might not always have been the worst option. Moreover, Kaplan’s assertion undermines his firm’s stance that artificial intelligence helps it identify the candidates in the best position to repay their loans. That is, if OppFi’s AI could actually accomplish this goal, then it ought to be able to lower its interest rates well below the theoretical break-even points.
OppFi isn’t the first fintech company that Racine has gone after: in June, he filed a similar suit against Elevate. Indeed it could be argued that Racine is picking off fintech lenders identified by the National Consumer Law Center; if so, the next targets may be Enova and LoanMart.
The trouble is, state-by-state patchwork regulation will always encourage a race to the bottom. The federal government can be more, or less, aggressive about trying to enforce rent-a-bank abusers, but if there is genuine interest in shutting down this kind of predatory venue shopping, then blanket federal rules are the remedy. We’ve had glimpses of this in the past; in 2017, the CFPB under Richard Cordray issued an ability-to-pay rule, which required lenders to assess a borrower’s ability to pay back a loan on time before approving a loan. In theory, this would end a substantial amount of predatory lending. Payday lenders filed suit, and under Trump-chosen leadership the CFPB joined the suit on their side and later threw out the rule.
Biden appointees—particularly at the FDIC, OCC, and CFPB—have a substantial opportunity to take action on this issue, but a permanent effective solution will probably require new legislation.