In the aftermath of the global financial crisis, fintech companies burst onto the scene with a dizzying array of exciting new products and services. While fintechs are perhaps best known for designing online and mobile applications that make it easy for consumers and small businesses to make payments and apply for financing, they also have introduced underwriting tools that help banks expand credit availability.
Rather than viewing banks as competition, many fintechs have elected to work closely with banks on new product offerings. In these partnerships, the fintechs have the technological expertise and creativity, while their bank partners bring expertise in lending, payments and complying with the panoply of laws and regulations governing their business. The combination has proved highly effective, with studies confirming positive impacts on credit availability, financial inclusion and the user experience.
Despite the demonstrated benefits of bank-fintech partnerships, consumer advocates and some regulators have criticized them for rendering many state licensing and usury laws inapplicable. Using the pejorative and inaccurate term “rent-a-bank,” these critics claim that we need more regulation of bank-fintech partnerships, often proposing measures that would destroy the benefits they offer to the economy and the public. However, these sentiments are misplaced.
First, the claim that bank-fintech partnerships are unregulated is simply untrue. In a typical bank partnership program, the fintech markets and services loans. But the loans are in fact made by the bank, not the fintech.
In many programs, the bank retains the loan on its books and sells only a participation interest to the fintech. As a heavily regulated entity, the bank is subject to robust supervision by state and federal regulators, including with respect to well-established guidance on subprime and predatory lending.
The bank is required to conduct rigorous due diligence on the fintech at the outset of the relationship, and to oversee and monitor the fintech’s marketing and servicing of the loan throughout its life (even if the bank sells whole loans to the fintech after origination). Existing law also subjects the fintechs to examination as service providers to banks.
Bank-fintech partnerships are governed by program agreements that require the fintech to comply with the stringent regulatory requirements that apply to the bank, and to be subject to heavy bank oversight, including frequent compliance audits. Fintechs that partner with banks often must maintain state licenses for brokering, servicing, collections and other activities, subjecting them to direct supervision by state licensing authorities.
Second, the suggestion that bank partnerships exist solely to “evade” state usury limits and licensing laws is misguided. It is true, of course, that banks partnering with fintechs can lend nationally at the rates permitted by their home states. They can do that whether they are partnering with a fintech or not.
Additionally, in many bank-fintech partnerships the bank offers loans at rates that would be permitted under state law anyway, so targeting these partnerships for this reason alone would throw the proverbial baby out with the bathwater.
As for the question of whether there should be a national usury limit or limits on rate-exportation authority, the Supreme Court recently made clear that this is an issue for Congress. To date, Congress has steered clear of lending price controls because enacting such a law would reduce credit availability and push consumers toward even more costly alternatives.
The proposed regulation of bank-fintech partnerships would substantially impair innovation, harming consumers, small businesses and banks. If fintechs can’t partner with banks, they will have to lend directly.
Direct lending requires huge upfront investments in the procurement of lending licenses, as well as larger ongoing license management and multijurisdictional compliance programs.
We know firsthand that these costs can deter some fintechs from offering new products. Furthermore, the creativity and technical skill of fintechs has helped smaller banks, allowing them to leverage the internet and mobile applications to offer a better user experience, create opportunities to serve customers outside their traditional footprint, and improve their efficiency while reducing credit risk. Restricting bank partnerships can only harm these banks, which often lack the resources to develop their own technology enhancements. The unintended harm to these banks is that their customers will be deprived of a better user experience and have less access to innovative credit products.
By continuing to permit these partnerships to combine the trust, reliability and stability of a bank with the innovative offerings of a technology company, we can ensure continued competition and provide real benefits to consumers and small businesses.