This blog post has been adapted from remarks to IECs lunch briefing “Free to Thrive: A pro-growth agenda for 116^e Congress, ”which took place at the Russell Senate Office Building on Capitol Hill.

While the 115^e Congress did not realize all that was hoped for with regard to the reform of financial services, it has made significant progress in achieving a more free and competitive system by adopting Senate Bill 2155. However, while S. 2155 was an important bipartisan victory, something was clearly missing: fintech reform. This should be a bipartisan priority in the 116^e Congress.

Fintech, especially when it comes to personal and small business loans, is an incredibly promising innovation – it promises to deliver credit in a faster, cheaper, and easier way than traditional products like credit cards. credit or installment loans. The problem, however, is that there is no national charter for non-bank lenders, like there is for banks. Banks that get a federal charter have the ability to “export” their interest rate across the country, charging a flat rate of interest, but fintech companies don’t have that option. This means that if a fintech lender – which is not a bank – wants to operate nationally, they have two choices: a) try to get a license and be held accountable by the state regulator in all 50 states. , which can cost up to $ 30 million upfront (not to mention ongoing compliance costs), or b) “partner” with a nationally chartered bank and therefore can export its interest rate .

While this arrangement is problematic in itself, it was made even worse by a decision of the Second Circuit Court of Appeals. Madden Financing v. Midland (2017) – a decision that should be fixed by federal legislation.

Madden was a Second Circuit case, spanning New York, Connecticut and Vermont, which asserted that a valid loan from a bank can become usurious if sold to a non-bank financial institution.

More precisely, Madden involved a New York borrower who opened a credit card with a nationally chartered bank that charged an interest rate allowed in the bank’s home state, but higher than the interest rate allowed by the New York State. When the borrower defaulted, the bank sold the debt to a debt buyer, Midland Funding, who then sought to collect the outstanding debt. The Second Circuit held that while the National Bank Act (NBA) prevents state usury limits for nationally chartered banks, it does not prevent state usury limits for the sale of a bank. debt to a non-bank debt buyer, who therefore could not collect the loan. .

Although technically unrelated to fintech loans, the case casts doubt on the enforceability of these types of loans due to their business model. Since non-bank fintech lenders are currently not federally licensed, they are relying on this banking partnership model to take advantage of banks’ ability to export their interest rate. The second circuit Madden ruling, however, made this business model illegal.

The problem of reasoning in Madden is its disregard of the common law contractual doctrine of “valid once made”. The validity-at-date doctrine states that a loan which is valid at the time it is made cannot become usurious upon its transfer to another entity, a doctrine which has been the cornerstone of banking law for almost two years. centuries. In the Supreme Court case of 1833 Nichols vs. Fearson, for example, the court wrote that “However, the rule of law is everywhere recognized, that a contract free of usury from its creation will not be invalidated by subsequent usurious transactions on it”. Unfortunately, the court did not take this fundamental doctrine into account in its analysis.

In addition, the National Bank Act, originally passed in 1863, establishes federal pre-emption of state usury laws for nationally chartered banks. According to 12 US Code § 85, the usury limit on loans granted by national banks is determined by “interest at the rate authorized by the laws of the state, territory or district where the bank is located”, a fact confirmed by the Supreme Court in the 1978 decision, Marquette National Bank v. Premier of Omaha Serv. Corp. Crucially, this Section 85 pre-emptive power also encompasses the power to transfer the right to enforce the interest rate of an agreement. 12 US Code § 24, for example, makes it clear that an additional power of a nationally chartered bank is the power to sell loans.

Experts from all political circles have criticized the Madden decision. For example, Donald Verrilli, The Obama administration’s solicitor general, as well as the Office of the Comptroller of the Currency, called the decision “IncorrectWith an analysis that reflects a “misunderstanding” of section 85 and the Supreme Court precedent.

Not only the decision Madden is deeply flawed, but it has proven to be disastrous for second channel fintech companies.

Two major studies examined the impact of Madden decision on access to credit and personal bankruptcy, respectively. the first study To observe the economic impact, the number of loans granted to less creditworthy borrowers in the second circuit decreased by 52%. Meanwhile, the number of loans to similar borrowers outside of the second channel increased by 124%. the second study, written and presented to Philadelphia Federal Reserve by two university researchers, found an 8% increase in personal bankruptcies in the Second Circuit states due to the decline in loans in the market. Overall, the authors concluded that “our results suggest that withdrawal from access to new lending technologies has detrimental effects on well-being in terms of increasing the incidence of personal bankruptcy, in particular. particularly among low-income households. ” This result should come as no surprise, as loans in the market are commonly used to consolidate debts and provide liquidity to households, reducing the likelihood of bankruptcy.

Without legislative solution for Madden, the states of New York, Connecticut and Vermont will miss out on the enormous benefits of new types of lending technology. Consumers in these states will always be at a disadvantage as they lose access to cheaper and more convenient loans that have been shown to reduce hardship. Meanwhile, innovative companies have lost access to one of the largest markets in the United States, as evidenced by the dramatic decline in lending in that country, reducing their ability to grow and expand their businesses. In order to embrace the potential of fintech, Republicans and Democrats should unite to pass the “Madden Fix“, The law” Protecting consumers’ access to credit “.