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AFC SERIES: True Lender Debate: Navigating Fintech & Regulation
The disapproval of the OCC’s True Lender Rule in 2021 sparked a seismic shift in the fintech lending space, leaving a cloud of uncertainty over the regulatory landscape. As states roll out new true lender definitions and federal guidance remains elusive, the future of bank-fintech partnerships hangs in the balance. In this episode, we dive deep into the disruptive changes reshaping the industry, explore the potential impact of the new administration’s regulatory agenda, and debate what it will take to balance innovation with consumer protection. Tune in for a forward-looking discussion on what’s next for fintech lending in a rapidly evolving regulatory environment.
Hosts: Rachel Morrissey, Money20/20 US
Ian P. Moloney, SVP, Head of Policy and Regulatory Affairs
Guest: Martha O’Malley, Assistant General Counsel, Prosper
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Welcome to the Money Pot. I am Rachel Morrissey. I am from Money 2020. I'm our head of content for the US show and the executive producer of the podcast, and I am here with a special series that we're doing with the American Fintech Council about all of the things that are really going on in Washington DC and the very quick turn of events that have happened there over the last couple of months and what's going forward. Today, we're going to be focusing specifically on navigating fintech and regulation with the true lender debate, and so, before we get much further, I want to introduce my co-host, ian P Maloney. He's the Senior Vice President of Policy and Regulatory Issues at the American FinTech Council. How are you, ian?
Ian Moloney:I'm doing well, Rachel. How are you doing today?
Rachel Morrissey:Good, are you up for this? Are you ready to co-host?
Ian Moloney:Oh, I am so ready to co-host and I feel like we should put a little not a parental advisory sticker but maybe a wonk advisory sticker, because this conversation is going to get really wonky really quick. But I'm excited for it.
Rachel Morrissey:I love wonky. Our listeners love wonky. They come to us for wonky, so we're going there. So joining us to talk about the True Lender debate is Martha O'Malley. She's the Assistant General Counsel for Prosper. How are you doing, Marty? I'm well, thank you. How are you, Rachel? I am good. We're so glad that you decided to join us today. We're excited to talk about all of the different issues around the nature of the True Lender debate. It's been a really interesting history Going over the past 10 years. It feels like we go back and forth on a pendulum here pretty quickly, depending on whoever is in charge. So why don't we start there? Ian, do you want to kick us off with the first kind of intro and idea?
Ian Moloney:Yeah, absolutely, and I know, you know, as I mentioned, it's going to be a wonky conversation, but we should definitely set the ground a little bit, set the stage, and so, you know, Martha, I think it would be helpful. You know, recognizing, you know Prosper has been in the mix pretty heavily on True Lender issues, AFC. This has been a huge issue for us as well. Can you just kind of, you know, give us a brief overview of the issue and any regulatory and legislative issues?
Martha O'Malley:Sure, I'm happy to talk about this. So Prosper is kind of one of the grandparents of fintech lending. Prosper began lending in 2006, so it has a very long and established history in fintech lending. Prosper is no longer a lender. Prosper is a bank partner, and that really sort of ties directly into the true lender question. And true lender really affects the bank partnership model, and what that really means is that's a partnership between the funding bank that makes and issues and originates the loan and a partner which may do a variety of services for the bank, such as marketing or advertising or servicing the loan.
Martha O'Malley:For the bank partnership model has proven to have a number of benefits for both the banks and for consumers, and I think I'll stop there and sort of talk a little bit about that and then we can shift over to TrueLender. So, for the bank partnership model just really at a high level, has benefits to banks in that it allows banks to extend their lending activities. It's particularly helpful for community banks so that they can extend their ability to lend beyond their brick and mortar geographical presence. It's also and there are studies that back this up up there are 2018 Basel Committee studies that back this up that show that actually, banks need to move more and more in this direction to increase their ability to reach consumers and to meet the demands of a competitive environment. On the flip side for consumers, there are a lot of benefits for consumers. They're more able to have consumer choice. They're more able to get access to different products, and it's been shown through a number of studies, particularly a 2018 Philly Fed study that shows that more consumers are able to get access to financial services and products through the bank partnership model.
Martha O'Malley:So I want to set the stage that there are a lot of benefits to financial services in having the bank partnership model. So you may ask and I promise to keep this relatively brief, that's great. How does true lender play into that? And the true lender doctrine really is the theory that the true lender of loan is not the bank but is instead the fintech partner. And the true lender seeks to recharacterize the fintech partner as the lender through a couple of catchphrases that you'll hear over and over again which is either the predominant economic interest or the totality of the circumstances, and it attempts to apply these tests or apply regulatory requirements to recharacterize a partner as the back.
Rachel Morrissey:Okay.
Rachel Morrissey:So this is interesting because the history of it, the history of this, of the regulation around this, has kind of flipped back and forth.
Rachel Morrissey:Initially, during the first Trump administration, there was a rule put out by the OCC that made it kind of uniform nationally, that there was a rule that was the financial services and fintech was very much in favor of right Because it did exactly what you did, which, what you were talking about, which is it allowed for these bank fintech partnerships to really flourish in this way? And then the Biden administration came in and they became concerned with predatory behaviors that were possible because of the nature of the rule and Congress passed legislation against it and Biden signed it and nature of the rule, and Congress passed legislation against it and Biden signed it and they killed that rule. And so now we're back into the what's going to happen next model, like how's the pushback going to go? Is this going to get reversed again? How will it get reversed? Do I have that right? Is that a fair summary of the events or the major events of the last little while?
Martha O'Malley:I think at a high level. That's a fair summary. I think in each of those prongs there's a lot of additional detail, but I think that's fine to set the stage.
Rachel Morrissey:Okay, good, okay, so let's look at this In lieu of the federal fix, states have taken their own approach deciding the true lender issue, and there's certain states like Washington, new Mexico and Illinois that have pursued fairly similar laws related to true lender, while the traditional regulatory leaders of California and New York have pursued different activities on this issue. So, based on your understanding of the state regulatory landscape, how do you see the idea of regulatory diffusion occurring on the true lender issue?
Martha O'Malley:Sure, so I think there are several avenues that the states have taken and, if I can sort of delve a little bit back into history, we see the first state legislative regime enacted in 2011 in Georgia, and Georgia was the first state to codify a predominant economic interest in the totality of the circumstances test, and then from there the activity shifted largely to the courts, and you see actions in Delaware, you see actions in West Virginia, you see actions in different places in the courts, but, starting in the early 2020s, you see activities at the state level in the 2021, 2022, 2023 area, and those statutes fall, generally speaking, into two buckets.
Martha O'Malley:One bucket is state regulations that, based on anti-evasion provisions, attempt to use the activities that a partner might engage in, like marketing, arranging or brokering the loans, or holding or acquiring the predominant economic interest, to use those activities to recharacterize the partner as the lender, and that's been put into statutes in states like Illinois, maine, new Mexico, washington State.
Martha O'Malley:There's another avenue that we see relatively frequently, which is to impose licensing requirements on the bank partner, and these may be your normal licensing requirements or the licensing may take effect around certain loan sizes and certain interest rates of the product issued by the bank, and we see that in certain states again in the 2021 area, but we see that in states like Wyoming, nebraska, connecticut and Wisconsin. So we see those two avenues. There are other avenues that we see sort of in Maryland, we saw an action in the early 2020s to require the bank to be licensed by the state, which is a very unusual action for a state to take. And then we also see, more recently in the last couple of years, actions by the states to opt out of the federal banking regime, what's called the DIMACA opt out. So there are a number of different avenues that that we see being taken by the states.
Ian Moloney:So I think that's something that really you know. I know we've been thinking about a lot at AFC and you know that sort of patchwork nature that you see developing. I mean, these are the buckets that you mentioned. You know are very different in how they impact the industry. So I'm wondering if you could just give us a sense of you know when you're partnering with your banks and when you're, you know, helping to put out these loans. How do these different state laws really impact the work that you're doing at Prosper and then also with your bank partners?
Martha O'Malley:Yeah, so it's a really important impact. So, to set the stage, we believe in responsible, innovative marketing and access to credit for consumers and we take that stance with our bank partner. We also prosper as a marketplace, so we have institutional investors that participate on our platform and our investors take that stance as well. We're all very concerned that we should adhere properly to both federal and state laws. So how that plays out, in response to your question is we may voluntarily not allow the product to be issued through our platform above a certain interest rate if a state has a cap.
Martha O'Malley:So, very simply, like the Madden states are a good example, like the Madden decision is still law in New York, connecticut and Vermont. So one thing we might do is say okay, we're going to assume that the Madden rates are the rates that will be available for products issued through our platform, rates that will be available for products issued through our platform. Or there might be another state, say, for example, washington State, that might impose a requirement. We might think that we're not actually subject to that requirement, but we might nonetheless impose a cap on the product issued through our platform so as to avoid having to have that conversation or avoid the regulatory scrutiny, which is time consuming and potentially expensive, and what that means is that there may be consumers in those states that we will not reach, because we simply don't want to take the regulatory risks and we won't extend our products to those museums.
Rachel Morrissey:So, just so our listeners have a better sense, I mean, could you just, in a very short kind of term, outline what the Madden approach is specifically like, just so people get an idea of what that means when they're listening to this? If you're not talking to Washington insiders or people who are following this tightly, how would you describe that?
Martha O'Malley:Yeah.
Martha O'Malley:So, as Ian said, this will get very wonky very quickly.
Martha O'Malley:Um, I will try and encapsulate it because the Madden decision sort of approached it from a slightly different angle, which was the idea that a bank that had lawfully made its loan and then sold it to a non-bank party, that the non-bank party could not carry the interest rate on the loan that was issued by the bank. And this is sort of challenged by banks and it's called the valid when made doctrine, which is a longstanding doctrine that says that the purchaser of a loan validly made is entitled to the rights and benefits of that loan. The Madden decision, writ large, really upset that certainty of the valid when made doctrine and it is in effect from a judicial interpretation in New York, connecticut and Vermont. But there is a federal regulation that says that loans, when issued through a bank, are invalidly made, the rights and benefits due in order to the subsequent purchaser of the loan. So the valid when made doctrine is similar to the true lender doctrine but it really goes to the person who purchases the loan. The true lender doctrine goes to the person who makes the loan.
Ian Moloney:I think you're kind of circling back to the points, marty, that you were making around the costs and the impact on consumers. I mean, it seems like those are two very significant considerations for prospering, kind of, for the industry overall, and so, thinking about all these different states, all the different potential costs, and kind of how you're able to serve or not serve certain consumers, which is the benefit of fintech, right, you want to be able to serve those that have been historically underserved, you know, do you think it's time for a federal fix? You know, I mean, we have the valid when made fix, and so it seems natural that, even with all the politics and the issues that have happened previously, there still needs to be a federal fix. And, if so, like what does that look like for you? What's the path forward?
Martha O'Malley:I think a federal fix would be really beneficial. I think it would be beneficial for a couple of reasons, including providing certainty. I think the current regulatory regime is fragmented and complicated and overlapping. I think no one really benefits from that kind of uncertainty. So I think a federal regulation, or federal legislation even, would provide incredible certainty. That would be really helpful to settle this issue and allow the states and allow others to focus on issues that are important to them. There are state regulations that around servicing or around collections. There are privacy laws. There are other areas where the states can focus their efforts in their supervisory activities. The partners are all subject to those state requirements, and so a federal law that would, or a federal regulation that would provide clarity, certainty, level the playing field, would really be beneficial both to participants in the market and to consumers.
Rachel Morrissey:So what would be the limits that you would put on federal legislation If you wanted states to be able to focus on certain things and the federal legislation to be focused on other things? Where would you kind of want to draw the line so that the federal fix wasn't kind of overdone or underdone, like if we're looking for just right and we're Goldilocks looking for just right, where does that sit?
Martha O'Malley:I think a federal rule could rely on existing federal supervisory structures. The banks already have a piece of law that is available to them it's the Bank Service Company Act and it provides that bank service providers are subject to supervision and examination as an adjunct of the bank itself, and it provides that the bank may engage in activities through service companies and to allow it to promote its products, and so a law that sort of reincorporates and reinforces that banks can do this through the Bank Service Company Act will protect banks' traditional powers to pursue their traditional activities through service providers to the bank and clearly brings that through the bank supervisory regime.
Rachel Morrissey:I mean, I think that makes a great deal of sense. So how much would clarity around that particular layer of federal oversight versus? You know you were mentioning some of the different layers the states would then possibly add to it? The states would then possibly add to it. How much would that really shift the clarity for the fintech community? I know it will. I just want to know what do you expect that to do?
Martha O'Malley:I think it would provide clarity that a bank engaging a non-bank to perform these activities are the powers of the bank and it does not re-characterize the partner as the lender. So if you clearly designate that area as the banked acting, in and of itself it prevents the re-characterization of the partner as somehow being a lender. So it would to use a super wonky legal term it would preempt all of the state statutes that are modeling the activities of the bank versus the activities of the partner. So I think it would really sort of effectively put an end to this mixing together of who's doing what and make it very clear that it is the bank doing these things. But the bank remains the lender even as it engages a partner to perform non-lending activities.
Ian Moloney:So kind of keying in on the preemption aspect, which I know is very important in today's discussion. It's very important, kind of, in the broader political discussion that's going on. What would a federal fix really do to the existing state laws that have already passed, and what would you see as potential challenges out there if folks were to pursue, either through regulation or legislation, a federal fix?
Martha O'Malley:Yeah. So I think that, on the upside, a federal fix would, as I mentioned, provide clarity for the actors in the space, for the banks, for the partners and for consumers. There are actors who might be disadvantaged by this, so, for example, well-meaning state legislators who had acted to protect their consumers. They may see this as infringing on their powers to protect the consumers in their states, and I think the answer to that is a lot of education about how this would actually ultimately benefit the consumers, not only in their states, but also in all states. And so there are, you know, well-meaning legislators and well-meaning advocates who want to protect consumers, and they may initially be displeased, frankly, by the federal government coming in and sort of overriding some of their efforts. But I think it's important to remember that we're all trying to get to the same goal responsible access to credit for American consumers and getting there through a platform of clarity and regulatory certainty will help all of them. A clear, even tide raises access to credit for all consumers, to borrow a metaphor.
Rachel Morrissey:It's a good metaphor borrow away. Um, I do have one a little um question around. That is is do you guys have any research or do you have any sensibility about what kind of overall improvements this would be for the consumers? Um, because, at the end of the day, if all of this back and forth is about how much do we protect the consumer from any kind of predatory lending and then how much do we actually are we keeping them from responsible lending that would benefit them, then, you know, do we have any numbers that could kind of clarify that has?
Martha O'Malley:penetrated areas that have lost traditional bank branches and has allowed consumers to obtain credit at lower rates than products issued through traditional banks. There's also a 2018 study by the Federal Reserve Bank of New York that says that really focused on mortgage lending, but it said that technological innovations by mortgage lenders improve the efficiency of the mortgage lending market and benefits to consumers included things like timely processing, quicker responses to fluctuation in demand and overall lower levels of consumer delinquency. And then, on the flip side, there are some sort of negative consequences to consumers, which basically said that the number of providers in Illinois shrunk by approximately 40%. Now, I think not everyone would say that's a terrible thing. That may have been the point of the act and that's fine, but my point generally is that these regulations do have effects on the consumer market, and so, where we draw those lines, it'd be better to have them as a uniform federal presence rather than have access to credit restricted state by state.
Rachel Morrissey:Thank you so much for being with us today, Marty. You've been great. That's about all the time we have, Ian. Do you have any final questions you want to ask before we?
Ian Moloney:wrap this. I think Marty covered everything so well and really framed up the conversation, so thank you very much for joining.
Rachel Morrissey:She didn't, even if you do ask hard questions. I think she batted pretty well on that. I think she did a great job, so thank you so much. I want to thank you so much for being here today and, ian, thank you so much for co-hosting with me. I look forward to co-hosting the next one with you as well. We've got one more that you and I are going to be doing together as part of this series, and I want to thank our audience. Please go ahead and write us any ideas that you have for podcasts at podcastmoney2020.com, and have a great day.
