CREDIT, USURY, & MODERN APPLICATIONS, Vol. 1
Credit and its ugly cousin usury are ancient concepts, the latter often seen in a negative light. Truly, usurers were held in Dante’s Seventh Circle, somewhere in between heresy and fraud. In its modern application, credit was used by the Dutch to dethrone a noncredit worthy Spain and further spurred the French monarch’s downfall during the Mississippi bubble. Currently, financial technology has altered the landscape of how credit is obtained through the use of peer-to-peer (P2P) lending platforms.
P2P lending platforms function as an intermediary, connecting borrowers and lenders. In theory, P2P lending should make markets more efficient because it allows access to otherwise inaccessible capital by connecting borrowers and lenders in a manner unrestricted by physical boundaries. However, debtors are finding their interest rates to be unsustainable for whatever reason as evidenced by recent court cases discussed below.
On one hand, assuming full disclosure, all three parties are independently transacting with each other in an otherwise private fully disclosed manner. Nevertheless, a borrower who cannot find credit elsewhere is susceptible to assuming a high-interest loan without the ability or foresight to repay in full. Most recently, regulators are attempting to balance the scale between banks, nonbanks, and borrowers.
Marketplace lenders are restricted by a number of forces, including usury laws, which limit the amount of interest a lender can charge a borrower. In the U.S., states hold the power to regulate usury and the maximum legal interest rate at which consumer loans can be made. Consequently, the maximum interest rate can vary among states. Moreover, a state-charted bank under Utah law can escape the usury laws of New York through an exemption that allows state-charted banks to “export” their interest rate if it doesn’t exceed the maximum rate allowed under the funding bank’s state law.[1] In effect, third-party nonbanks can seek shelter under Utah law, which has no usury limit, and charge rates that exceed the rates where the borrower is domiciled, such as New York where a usury limit exists.[2]
P2P platforms, such as LendingClub, are nonbank entities and contract with Utah-like banks to use the funding bank’s exemption status to circumvent state usury laws—a practice known as “renting-a-charter.” Most recently, in Madden v. Midland Funding, the Second Circuit Court found that a funding bank had not retained an interest when the loan was assigned to a nonbank third-party, bounding the third-party to state usury limits. Consequently, banks and nonbanks in Second Circuit states now structure their agreements to ensure funding banks retains an economic interest, contrary to the idea of an assignment or outright sale. Other areas of the country, such as California, are in disarray and disagreement as to how to balance the interests of banks, nonbanks, and debtors. Moving forward, two cases concerning rent-a-bank charters are to be heard by the Ninth Circuit court where the application and scope of California usury laws will be further defined.[3]
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