Banking On It

The fintech revolution has spurred a host of legal questions concerning online lending. Developments at both the federal and state level are beginning to provide some answers.

The Biggest Changes to Fintech in 2018

Catherine M. Brennan and Nora R. Udell

December 11, 2018 01:59 PM

For many years, partnerships have allowed banks to offer loans to consumers and businesses by leveraging the resources of nonbank entities. In the internet age, many financial-technology, or “fintech,” companies have become partners, offering solutions for banks seeking to extend credit and other products to customers. As the pace of innovation increases, federal and state regulators, legislatures, and courts have responded when they see the need to regulate what is essentially a business relationship between a bank and a service provider. Here’s a look at recent developments.

Unconscionable Loans in California

In De La Torre v. CashCall[1], California’s Supreme Court held that the interest rate on a consumer loan of $2,500 or more may render the loan unconscionable under the California Financing Law (CFL)—even though the statute does not set an interest cap. The court was responding to a certified question from the Ninth U.S. Circuit Court of Appeals.

This case opens the door a crack for consumer claims that high-rate loans are unconscionable, but the door will be difficult to push further. The court reiterated that an unconscionability claim requires fact-intensive inquiry regarding the circumstances of the loan, and that a loan must be both procedurally and substantively unconscionable to meet the standard.

The court also acknowledged that unsecured loans to high-risk borrowers often justify high rates. Moreover, the remedies available are limited to restitution and injunctive relief and do not include attorney fees or damages. The court observed that the “relative paucity of remedies . . . should serve to limit pure attorney-driven lawsuits (since no attorney fees may be recovered) as well as blackmail settlements (since no money recovery beyond restitution is possible).”

Although it did not specifically address bank partnerships, CashCall echoes in that space because of how it will affect rate exportation—the authority under which a national or state-chartered bank in one state may charge the interest rate permitted by its home state to a resident of another state, even if the bank’s home rate exceeds that permitted in the consumer’s state.

CashCall affects rate exportation because interest rates imposed by a bank exporting California’s interest-rate authority appear to be limited by unconscionability concerns. It relies on the unconscionability standard codified in California’s Civil Code, which is incorporated into the CFL. Although the CFL does not apply to banks, the California Civil Code does.

Under regulations from the Office of the Comptroller of the Currency (OCC), meanwhile, banks’ exportation authority is limited by state law relating to “that class of loans that are material to the determination of the permitted interest."[2] Accordingly, even when banks export interest from outside the CFL, they will be limited by the Civil Code’s unconscionability standard.

CashCall is exciting because it has decided a new question of California law. Although the decision’s implications for rate exportation are important, the case is unlikely to drastically alter banks’ lending operations, whether they’re lending to California consumers or under California law.

OCC and Fintech Charters

In July, the OCC announced that it will consider applications for national bank charters from fintech companies that conduct the “business of banking,"[3] which includes the core functions of receiving deposits, paying checks, and lending money. Fintech companies must perform at least one of these to be eligible for a national bank charter as a special-purpose national bank (SPNB).

With its announcement, the OCC released a policy statement and a supplement to its comptroller’s licensing manual, which sets out the considerations that apply to fintech companies. The supplement notes that newly chartered SPNBs will face more frequent and intensive supervision from the OCC in their early years.

Additionally, because the OCC expects applications from fintech companies that do not receive deposits, the agency will impose certain conditions on approved applicants—conditions specific to SPNBs because such entities are uninsured by the FDIC. These structures will provide extra protections for consumers, who will not be able to seek recourse against FDIC insurance in the event of a loss. The agency will require that a fintech company have a contingency plan to sell itself, wind down, or merge with a nonbank affiliate. SPNBs must also maintain a minimum capital level account for sufficient liquidity under stress.

It remains to be seen which fintech companies will shoulder the burden of being among the first OCC charter applicants.

Federal and New York Reports

The Treasury Department and the NYDFS released reports this summer on fintech and online lending, respectively. Though each addresses bank partnerships, they offer opposing recommendations.

The NYDFS report, released in July, called for equal application of consumer-protection laws to online lenders; application of the state’s usury limits to all lending in New York; and licensing and supervision for all online lenders.[4]

The NYDFS saw bank partnerships as a regulatory concern, disagreeing with the position that the bank is the true lender and that the nonbank entity is thus not subject to New York’s licensing requirements. In many cases, it maintained, the online lender is the true lender. Although this appears to be a criticism of specific bank partnerships and not the bank-partnership model in general, the report nonetheless generally casts the partnerships as problematic.

The NYDFS was particularly concerned with interest rates on financial products offered to New York consumers—and the authority of nonbank entities to charge those rates. On that issue, the department cited with approval Madden v. Midland (2017),[5] in which the Second U.S. Circuit Court of Appeals held that non-national bank entities that purchase loans originated by national banks cannot rely on the National Bank Act to protect them from state-law usury claims.

The decision effectively disposed of the “valid-when-made” theory, which loan assignees have relied on for years. Madden suggested that a nonbank entity that purchases such loans cannot continue to impose the rates for which the bank contracted with the consumer unless it holds its own independent rate authority. (In some states the nonbank entity must hold a license to impose the rate for which the bank contracted.)

By contrast, the valid-when-made theory had established that when an interest rate was valid when the loan was made, the rate could not later be deemed usurious based only on the subsequent holder’s lack of independent rate authority.

The NYDFS report also opposed the Modernizing Credit Opportunities Act (H.R. 44391), a pending federal bill that seeks to overrule Madden. The department stated that if enacted, the bill “could result in ‘rent-a-bank charter’ arrangements between banks and online lenders that are designed to circumvent state licensing and usury laws.”

The Treasury Department later released its extensive report on the regulatory framework for nonbank financial institutions, financial technology, and financial innovation, detailing more than 80 recommendations, including three addressing bank partnerships.[6] It noted generally that bank-partnership arrangements have “enhanced the provision of credit to consumers and small businesses.”

To address constraints that “unnecessarily limit the prudent operation of partnerships between banks and marketplace lenders,” Treasury recommended that Congress:

  • Codify the “valid-when-made” doctrine (that the NYDFS rejects) to preserve the ability of banks and marketplace lenders to buy and sell valid loans without the risk of conflicting with state interest-rate limitations.
  • Codify that the existence of a service or economic relationship between a bank and a third party (including a fintech company) does not affect the role of the bank as the true lender of the loans it makes.

Treasury also said bank regulators should reaffirm (through additional clarification of compliance and risk-management requirements, for example) that the bank remains the true lender under such agreements. It further recommended that states revise credit-services laws, which apply to traditional loan-broker businesses, to exclude companies that solicit, market, or originate loans on behalf of a federal depository institution under a partnership agreement.

Federal Legislation Stalls

Notwithstanding Treasury’s recommendation to codify the long-established bank-partnership model, two bills that would do just that have not advanced since early this year. The House of Representatives passed the Protecting Consumers’ Access to Credit Act of 2017,[7] also known as the Madden bill, in February 2018. It would codify the valid-when-made doctrine and overrule Madden.

Similarly, there has been no movement on the Modernizing Credit Opportunities Act,[8] also called the True Lender bill, which was referred to the House Financial Services Committee in November 2017. The True Lender bill provides that an economic relationship between an insured depository institution and a nonbank third party that performs lending functions does not affect the determination of the institution’s location or its role as a lender.

Regulators, legislatures, and courts are not in agreement—but that’s no surprise. They are all responding in the bank-partnership and fintech spaces, and the important thing now is to keep up with them.


Catherine Brennan is a partner in Hudson Cook's Hanover, Maryland office. She primarily assists investors in the consumer financial services and alternative business funding sectors. Catherine engages in credit due diligence on behalf of investors in fintech firms, bank partnership platforms, small business lenders, merchant cash advance companies, consumer finance companies, title loan companies, and payday lenders.

Nora Udell is an associate in the Maryland office of Hudson Cook. She advises consumer financial services clients on federal and state regulatory compliance matters. On behalf of investor clients, Nora conducts due diligence of consumer credit programs.


[1] 422 P.3d 1004, 18 Cal. Daily Op. Serv. 7990 (2018).

[2] 12 C.F.R. § 7.4001(b).

[3] “OCC Begins Accepting National Bank Charter Applications From Financial Technology Companies,” OCC NR 18-74 (O.C.C.), 2018 WL 3629320 (July 31, 2018); 12 C.F.R. § 5.2.

[4] New York Department of Financial Services, Online Lending Report (July 11, 2018), available at pr1807111.htm.

[5] 786 F.3d 246 (2d Cir. 2015).

[6] “Treasury Releases Report on Nonbank Financials, Fintech, and Innovation,” Treas. SM-447 (Dept. Treas.), 2018 WL 3629322 (July 31, 2018). Full Report, available at sm447.

[7] H.R. 3299, 115th Congress, 2nd Session, 2017 CONG US HR 3299.

[8] H.R. 4439, 115th Congress, 1st Session, 2017 CONG US HR 4439.

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