Colorado can now move forward with a cap on what some out-of-state lenders can charge borrowers in interest after the U.S Court of Appeals for the 10th Circuit rejected a lower court ruling that blocked state efforts to set a limit.
At question were consumer loans that nonbank lenders were issuing through banks chartered in other states with no caps or very high caps on interest rates. Some lenders were just above the state’s limit of 36%, while others were charging rates approaching 200% a year.
“This is about consumers being protected from these harmful loans. It is also about state rights and whether Colorado can decide if the usury laws can apply to its residents,” said Andrew Kushner, senior policy counsel for the Center for Responsible Lending, one of several consumer groups supporting Colorado in its legal battle.
As lending has moved increasingly online, and as the bar on what was considered an acceptable interest rate has continued to move higher, Colorado has taken steps to protect consumers, especially in the areas of payday, alternative and installment loans, said Andrea Kuwik, director of policy and research at the Bell Policy Center in Denver.
Colorado voters in 2018 passed Proposition 111, which capped short-term payday loans at a maximum rate of 36%, down from the 186% a year borrowers had been paying a year on average between interest and fees. That measure garnered 77% support, an unusually high share for a ballot measure.
But lenders pivoted and began offering more “alternative” loan products with short terms and triple-digit interest rates. The Colorado Attorney General reached agreements with a couple of the more aggressive out-of-state banks. In 2023, the Colorado legislature sought to execute an opt-out provision in federal banking law to bring more of the banks into compliance, which triggered a lawsuit.
“These are the limits that are right for Coloradans and voters have made this a priority. The ruling gives them back their power,” Kuwik said. She adds that other states have been watching the case and could be encouraged to follow Colorado’s lead.
Consumer lending can be viewed as a three-tier cake. At the top are nationally chartered banks, which issue the majority of credit cards and have the best name recognition. Although they follow federal banking rules, including on disclosure, when it comes to limits on interest rates, they are under the “usury” laws of their home states.
The closest thing to a national usury law is a 36% cap on loans made to active duty military personnel and their dependents, but otherwise, national banks can charge what their home states allow. And no surprise, national banks tend to locate in the state with the loosest regulations on interest rates and consumer protections.
In the middle are state-chartered banks. Under the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980, state-chartered banks can make loans in other states, provided they follow the rules, usury and otherwise, of their home state.
At the bottom are nonbank lenders who must comply with state lending rules and licensing requirements. Technology has made it much easier for “fintech” companies to reach consumers nationwide, and some firms have found a willing market among consumers facing financial distress.
To get around state restrictions, fintech companies partnered with state-chartered banks in places like Utah, which doesn’t have a set cap on interest rates. Critics argue these “rent-a-bank” arrangements allow fintech companies to skirt the consumer protections states have sought to erect.
For example, Utah’s only limits are against “unconscionable” interest rates, but that term remains undefined and rarely enforced in a court system that has shown a propensity to side with lenders.
Colorado isn’t on the low end among states that have issued interest rate caps, according to a comparison from the National Consumer Law Center. But residents carry some of the highest debt burdens of any state, and lawmakers have fought back against lending practices considered predatory. In 2023, the state legislature enacted an opt-out clause under DIDMCA to prevent state-chartered banks from “exporting” higher-rate loans into Colorado. Iowa is the only other state that has an active opt-out provision.
Colorado’s law was set to take effect on July 1, 2024, but in March, the National Association of Industrial Bankers, the American Financial Services Association, and the American Fintech Council sued to prevent its implementation.
In June, right before implementation, U.S. District Judge Daniel Domenico ruled that under DIDMCA, a loan is granted in the state where the lender is located, not where the borrower resides, and issued a preliminary injunction. On appeal, a panel of three judges in the 10th Circuit Court of Appeals overturned Domenico’s ruling and issued a 2-1 ruling in Colorado’s favor on Monday.
Key to the case was an interpretation of the term “loans made in such states.” The majority opinion concluded that the phrase could be interpreted to include where the borrower is located, not just where the bank is based.
“Likewise, the public interest counsels against enjoining a validly enacted law from a democratically elected state legislature,” they stated.
Defenders of the high-rate loan products argued that state-chartered lenders would be harmed financially and put at a competitive disadvantage to the national banks. They also argued Colorado was limiting the credit extended to an underserved part of the population and thus harming them.
For example, borrowing money to cover a car repair could allow someone to keep their job, and borrowing to make the monthly rent payment could prevent an eviction and a cascading series of problems.
“This decision puts Colorado consumers — especially low- and moderate-income families — at risk of being cut off from safe, regulated financial services at a time when they need them most. It also puts Colorado’s local banks at a disadvantage, making it harder to attract responsible fintech providers and stifling innovative partnerships that help community banks remain competitive,” Phil Goldfeder, CEO of the American Fintech Council, said in a statement.
The American Financial Services Association (AFSA) has also criticized the ruling and warned it could undermine the nation’s dual banking system that allows for state and national charters. DIDMCA was created, in part, to allow state-chartered banks to compete more effectively with national banks. One way it does so is by giving them a consistent set of regulations to work under rather than a patchwork of varying state regulations.
“In short, Colorado should be able to oversee Colorado banks, but Colorado should not be able to tell a state-chartered bank properly overseen by regulators in Arizona, California, or Nevada under what terms it can serve consumers,” the AFSA said in a statement.
So why isn’t an interest rate of 36% high enough? The typical loss rate for credit card issuers is in the 2% to 5% range, and reached as high as 10% during the Great Recession, according to the Federal Reserve. But the large nonbank lenders that partner with state-chartered banks suffered loss rates of 55% in 2022, according to their public filings.
The reason they can afford to absorb those kinds of losses and lend to whoever shows up is that they are charging loans with annual percentage rates of 100% or more. Borrowers are made aware of what they will be paying and it is up to them to weigh the pros and cons.
But consumer advocates counter that those in a desperate financial situation may fail to appreciate how much high rates may end up costing them in the long term and fail to pursue other alternatives like pawning items or turning to friends and family. Kushner argues that some loans are so harmful to consumers that they shouldn’t be allowed.
“A credit product won’t solve the problem of someone not making enough money,” he said. “Being given a loan you can’t afford to repay is an injury. It isn’t a gift in any sense.”
Kuwik doesn’t dispute that the alternative loans can serve a purpose for consumers in a pinch, but argues that protections are needed, especially for those who find themselves in a bind and desperate. Until a national standard is set, residents of individual states should have the right to determine what is acceptable.
As for the lending groups that had opposed the state’s reforms, which they view as limiting consumer choices, they plan to keep on fighting.
“NAIB is exploring every legal option in response to this disappointing ruling. And we will continue to advocate for consistent, nationwide lending rules that protect consumers, promote innovation, and sustain the stability of America’s dual banking system, which relies on state charter banking,” NAIB Executive Director Frank Pignanelli in a statement.
Kushner, however, expects the ruling will create a national precedent that extends beyond the states in the 10th Circuit. He also doubts the U.S. Supreme Court will take up the case in a discretionary review.
“This decision is correct and we don’t anticipate those efforts will be successful,” he said.
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