Don't Let Outdated Laws Shackle Credit Innovation

By Knight, Brian | American Banker, July 29, 2015 | Go to article overview

Don't Let Outdated Laws Shackle Credit Innovation


Knight, Brian, American Banker


Byline: Brian Knight

Marketplace lending is helping hundreds of thousands of consumers save money, refinance debt, and obtain credit on better terms than previously possible. While the industry has made do under the current system, an outdated legal and regulatory regime is preventing consumers from enjoying the full benefits of financial services innovation, and as a recent court case shows, may stifle it entirely.

Marketplace lending -- also known as peer-to-peer lending -- is a general description for online lenders that use cutting-edge proprietary algorithms and more efficient processes to extend credit. Like banks, they are subject to considerable consumer protection regulations at the state and federal levels. Unlike banks, they do not rely on deposits for investment funds, which instead come from investors. Usually, marketplace lenders partner with banks to originate loans, which the lender then buys and services.

Research by the Federal Reserve Bank of Cleveland shows that consumers pay lower interest rates on marketplace loans compared to traditional bank debt (including credit cards), and that marketplace loans are primarily used by borrowers to refinance credit cards and other sources of debt. Unfortunately, our lending laws are outdated, as highlighted by the Madden v. Midland Funding decision at the influential U.S. Court of Appeals for the Second Circuit, which held that only banks can take advantage of certain laws essential to facilitating a national credit market. This recent ruling, and the obsolete laws it reflects, threaten to squelch the promise of marketplace lending and arbitrarily favor banks to the detriment of consumers.

[Coming this November: Marketplace Lending + Investing. Hear how participants in this fast-growth niche are using data and technology to propel lending into the 21st century.]

Federal law permits banks to "export" the interest rate they are allowed to charge in their home state to customers nationwide, without regard for other states' limits. Without this, banks would be forced to comply with the varying standards of every state, making a national credit market, with all of the benefits of access and scale that it provides, potentially impossible. Marketplace lenders partner with banks in part for the interest rate export, which is essential to allowing a consistent and scalable service.

In the Madden case, the Second Circuit held that a nonbank debt collector that purchased nonperforming debt from a bank was not legally entitled to collect the same interest rate as the bank that initially issued the debt. Rather, the court found that the collector could presumptively only charge up to the legal limit of the borrower's state of residence. …

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