Fintechs play an important role in consumer financial services, providing innovative products and consumer interfaces to increase access to financial products, meet consumer preferences and improve transparency.
To facilitate go-to-market strategies, many fintechs are partnering with banks in market lending arrangements.
Since regulators and consumer advocacy groups remain skeptical of such arrangements, fintechs should carefully consider the contours of the arrangement when structuring deals.
They should also prioritize their own compliance programs to minimize opportunities for oversight by regulators.
Regulatory suspicions about loan partnerships
Federal and state regulators and consumer advocacy groups have long been suspicious of lending partnership models.
They are particularly concerned about whether partnership models are used to circumvent state interest rate limits, recalling agreements between payday lenders and banks – under which banks were added to loan documents without actual involvement in the loan transaction. Opponents have come to view these deals as bank leasing schemes.
Historically, two categories of challenges have been raised to challenge these relationships. One, as shown in Madden vs. Midland Funding LLCopponents argue that the loan is essentially invalid after being sold, transferred, or assigned to a non-bank third party, even if the loan was valid at the time it was issued.
Second, the opponents argue that the loan was invalid at the time it was issued because the bank was not the “true lender”. For the second category, courts apply a multi-factor test, which may vary by jurisdiction, to determine which entity is considered the true lender.
For a time, federal regulators have worked to clarify this space through the rulemaking process, but those efforts have been followed by additional uncertainty.
In June and July 2020, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation issued final rules stating that interest on a loan “shall not be affected by the sale, assignment, or other transfer of the loan.”
The OCC also released a “True Lender Rule” in October 2020 to establish a rule for determining which entity made the loan. Congress then repealed this rule. Now, the question is subject to different case law in different jurisdictions.
More recently, Consumer Financial Protection Bureau activity has indicated that the current administration views these partnerships with the skepticism of the past and perhaps with a renewed fervor to question such models.
For example, earlier this summer, Zixta Martinez, deputy director of the CFPB, focused on what she called “bank leasing schemes” where lenders “claim that the bank, rather than the non-bank , is the lender”.
She said the CFPB is “looking closely at this issue”. This spring, the CFPB also announced that it would use its authority to oversee “large participants” in non-bank markets for consumer financial products and services.
A few months earlier, the CFPB had placed orders with five fintechs offering a “buy now, pay later” credit for information on the risks and rewards of the industry.
Federal Trade Commission involvement
Meanwhile, the Federal Trade Commission has placed the tech industry in its crosshairs. Recent enforcement activity has included several advertising-related actions by financial services companies.
The FTC also asked for comment on a wide range of technology-related topics, including in the area of financial services and on issues such as algorithmic discrimination and accuracy.
Without uniform and specific parameters to guide fintech-bank relationships, what can fintechs do to minimize the likelihood of regulators pejoratively labeling their businesses as a bank leasing model?
- Empower the bank to make the final credit decision, although the non-bank can provide specific terms under which they will enter into a financial transaction with the bank
- Structure the relationship so that the bank retains an interest in the consumer’s account and/or a financial risk in the transaction
- Consider state interest rate limits when structuring programs and products
- Consider the period before which a loan or accounts receivable are acquired from the bank, including the time of the borrower’s first payment
- Review the scope of any compensation for legal or regulatory fees
- Avoid general language that requires the non-bank entity to purchase “all loans” from a non-bank company
- Avoid any representation that the arrangement is solely or primarily for the purpose of protecting fintech from consumer protection laws
- Avoid misrepresentation in communications with borrowers about the existence of the partnership between the non-bank institution and the bank
Even when a banking partnership relationship uses a structure that maximizes the factors that lead to the conclusion that the bank is a genuine lender, fintechs should not forgo regulatory compliance oversight.
Both the CFPB and the FTC have emphasized the growing role that technology plays in the development and deployment of new products and programs. A strong commitment to consumer protection and compliance programs that implement a compliance-focused tone from the top will serve fintechs well through this period of intense scrutiny.
This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
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Kelley Barnabas is a partner in the Litigation & Trial practice of Alston & Bird and co-chair of the Financial Services Litigation team, focusing her practice on consumer protection and unfair competition litigation and enforcement matters for clients financial services and health care.