Why Using the CRA to get rid of the “True Lender” rule is a bad idea (even if you don’t like the…

It isn’t surprising that with a change in party control over the Presidency and Congress there would be an effort to undo some of the rules put in place by the previous administration. One such effort is directed at the Office of the Comptroller of the Currency’s (OCC) “True Lender” rule. The rule sought to clarify when a national bank or federal savings association (hereinafter “national banks”) was the lender making a loan, especially if the loan was sold or otherwise transferred to a third party shortly after its creation.

This rule is, to put it mildly, controversial and is now the subject of an effort to use the Congressional Review Act (CRA) to disapprove the rule (and potentially prevent the OCC from doing a rule on the question in the future, absent explicit Congressional authorization.) Unsurprisingly given that I submitted a comment in support of the rule I think congressional disapproval of this rule would be a bad idea, and I think it would be a bad idea even if you had serious concerns about the rule.

To state the obvious, Congress disapproving the rule would be a mistake because the rule provides significant benefits to the access to credit and innovation, which Prof. Charles Calomiris ably describes in his recent Congressional testimony.

However, it would also be a mistake because the rule does not do what its opponents fear it does. Many of the objections laid at the rule, to the extent they have merit, are more properly laid at the underlying national banking system that Congress established and Congress would need to reform. Further, even if you don’t think the rule is correct as a matter of law using the CRA is a bad idea because the CRA process itself may introduce significant impediments to the next Comptroller addressing the underlying problem. These two arguments are discussed in more detail below.

The Rule does not preempt state law

One complaint leveled at the rule is that it preempts state law governing interest rate caps. To understand why this is incorrect it is important to keep in mind a couple of things:

First — Federal law explicitly gives national banks authority to lend. As such, they can create loans, and because they have federal authorization to do so, federal law limits that power in terms of the type of loans that can be offered, and the terms (such as interest). This is controversial, with states resenting the preemption of their usury law by federal law.

Second — National Banks can sell loans. Federal law and regulation grant national banks the power to not only make loans, but to sell them. Because these are powers explicitly granted to national banks by federal law the limits of those powers are set by federal, rather than state law. In fact, while twenty-five state AGs cite the case of Community State Bank v. Strong in a letter to Congress supporting the CRA for the principle that “federal banking law does not immunize a bank from state usury law ‘if it is not the true lender of the loan’” they do so in an incomplete manner. The court in Strong held federal law would not apply to a loan unless the bank was the “true lender of the loan under federal law.” (Emphasis added). Defining who the true lender is under Federal Law is the preserve of Congress and the OCC, not the states.

This is what the OCC’s rule seeks to do in its new rule. It isn’t preempting state law, Congress has already done that when it established rules for national banks. As the Supreme Court noted in the Marquette decision the preemption of state usury law “has always been implicit in the structure of the National Bank Act.” All the OCC is doing is clarifying when federal law applies, which is necessary for the functioning of the system. This isn’t to say the rule doesn’t impact the application of state interest rate law, it clearly does, but it isn’t preempting anything by itself.

This national preemption of state law was, is, and always will be controversial. If Congress believes that changes are necessary it, and only it, can change the law to make those changes. Until and unless that is done however the OCC must administer the law as it stands, and this rule was created in furtherance of that goal, as well as the goals of clarity, predictability, and access to credit.

The Rule does not enable “Rent-a-Charter” schemes.

Another major complaint raised by opponents of the rule is that it would invite the use of “Rent-a-Charter” schemes to evade borrower state usury laws. For example, according to the recent letter from twenty-five State Attorneys General to Congress, the rule would encourage national banks to enter into “sham” relationships with non-banks “for the principal purpose of allowing the non-banks to evade state usury laws.”

The nature of this objection is not entirely clear. It can’t be enough that a national bank makes loans to borrowers at rates above that allowed by the borrower’s home state law. It is well established that national (and state) banks can lend on the basis of their home state law.

Is it that the bank sells the economic interest in the loan off of its books that makes it a “sham”? Or that the bank intends to sell the loan before it makes it? This appears to be the line taken by the AGs. They approvingly cite the line of cases that look to which party has the “predominant economic interest” in a loan, looking to factors “such as which party uses its own money to fund the transaction and who holds the ultimate financial risk.”

But is this the appropriate standard? Are there any non-“sham” reasons why a bank may make a loan with an eye to selling the economic interest in it? Of course there are. As Prof. Charles Calomiris notes in his recent testimony there are a host of valid reasons why banks may want to sell off the economic interest in the loans they make. These can include having too many potential worthy borrowers for their deposit base to sustain, diversification, and a comparative advantage in identifying and accurately pricing borrowers rather than holding or servicing loans. None of these reasons are “shams,” even though they all could lead a bank to sell off the economic interest in a loan, or even make a loan with the expectation of selling it.

One of the largest examples is loan securitization, where a bank will make loans (such as credit card, mortgage, or car loans) with an eye to selling the loans or the economic interest therein off of its books and into securities markets. If the real test for determining the true lender is who bears the ultimate economic interest or risk in the loan, wouldn’t securitization count as a “sham”?

This question was raised, albeit obliquely, recently in two cases out of New York that challenged the validity of credit card loans made by national banks to New York residents at rates that exceed New York’s usury limit. As is typical in securitizations the economic interest in the loans was sold to a non-bank subsidiary that then issued securities backed by that interest. The banks intended to securitize the economic interest in these loans from the beginning.

If the determining factor of who is the lender is who has the predominant economic interest in the loan then the courts should have held that the holders of the asset backed securities (ABS) where the real lenders. But they did not. Instead they decided that the bank was the true lender by looking at other facts, such as that the banks retained the customer accounts, serviced the loans, and set the terms of the loans.

Is this just accepting form over substance? No. Control over the loan is what matters. The banks, not the ABS holders, decided who could receive a credit card and the terms for the card. The banks might have taken into account the availability in the market of potential buyers for transactions from credit card users with these particular credit profiles, but at the end of the day it was the banks that controlled the terms and recipients of the credit cards.

It is the question of control that best distinguishes banks engaged in legal and valuable lending activities versus true “rent-a-charter” arrangements. The OCC has brought enforcement actions against national banks that entered into rent-a-charter arrangement in the past where the banks were passive tools to be used by their non-bank partners, rather than the controlling party that ultimately called the shots and policed the actions of its partners as required by law.

The rule firmly places responsibility on the bank for the loan. It requires that loans conform to the laws and regulations that govern the extension of credit by national banks, that the bank properly monitor any partners, and that the bank be legally responsible for the loan. The bank needs to be the party making the loan. It can use partners to help with issues like customer identification, underwriting, and servicing, and it can sell the economic interest in the loan; but ultimately the bank must exercise control. As a matter of law and regulatory responsibility, it is the bank that will be held responsible for the loan. It is hard to consider this relationship a “sham.”

This isn’t to say that there may not be cases where banks will fail to meet those requirements, but such cases are best served by supervision and enforcement, with the OCC being best positioned to sort the sheep from the goats.

A CRA doesn’t solve the problem; it likely makes solving the problem harder

Finally, even if you disagree with how the OCC addressed the problem you shouldn’t want the rule CRA’d. Why? Because doing so may make it much harder for the next Comptroller to address the issue and will force the issue back into the courts, creating further uncertainty. Remember, the ability of a national bank to make and sell a loan is determined by federal law. If federal law does impose some sort of “predominant economic interest” requirement, the OCC is the proper actor to make that clear. If the law does not have that requirement, neither the states nor the Comptroller can insist on one.

Using the CRA to undo this rule could preclude the next Comptroller from putting forward a new rule to provide clarity to this question because the CRA would prohibit the OCC from putting forward a new rule that is “substantially the same” or takes “substantially the same form” as the rule that was CRA’d. It is unclear whether this prohibition would apply only if the OCC put forward an effectively identical rule or if it also would apply to a new rule that addressed the same issue, used similar analysis, or drew on similar authority. Putting the new Comptroller under a cloud of uncertainty is not likely to be the most effective way to resolve any concerns.

Rather, congressional disapproval would prolong uncertainty and leave the question to the slow and unpredictable process of litigation. National banks have certain powers under the law that state regulation cannot limit. Courts are divided on whether predominant economic interest is the correct way to determine who the lender is (See footnotes 148 and 149 of the linked article for a partial list of conflicting cases.), never mind whether state law can bind national banks on this issue. It will likely take years for the Supreme Court to resolve these issues conclusively. Continuing unpredictability will only hurt potential borrowers.

If Congress wishes to rethink the powers of national banks it may amend the law. If the new Comptroller believes that the former Comptroller’s rule missed the mark, the new Comptroller should revise the rule, but a CRA disapproval will simply delay a necessary process to the detriment of borrowers, lenders, and the economy generally.