Recent legislative developments are aimed at closing gaps that allow new financial products to avoid traditional lending regulations, as financial services offerings continue to evolve. 

Earlier this week, the Federal Deposit Insurance Corp. withdrew its amicus brief supporting Colorado law that allows state-chartered banks to opt out of federal preemption and follow Colorado's interest rate cap. The law is currently being challenged in the Tenth Circuit Court.

Meanwhile, a new bill in Virginia, introduced in January, aims to impose a 12% interest rate cap to prevent fintechs from evading usury limits, which cap the amount of interest lenders can charge on loans. The bill awaits sign-off from Gov. Glenn Youngkin. 

Though it is common for states to have usury limits, which have been around for hundreds of years, the Colorado law and the Virginia legislation aim to tackle the same issue: the explosion of lending that involves banks partnering with fintechs to offer loans via the internet, according to James Kim, a partner at Troutman Pepper Locke. 

Both laws could negatively affect fintechs and banks, particularly in Virginia, where subprime borrowers may be excluded from loans, he pointed out.

“The more recent trend is trying to extend the coverage of the usury cap to cover new, innovative products typically offered by or through fintechs, where a bank in Utah partnering with a fintech in New York or California can lend to a borrower in Colorado or Virginia,” Kim said. “And then the question is, do you have to follow a usury limit in Colorado or Virginia?”

The two states are trying to address a similar issue in different ways, he noted, adding that some states, including Colorado, are trying to close the “loophole” that allows fintechs to evade the usury limit.

Colorado opt-out

Kim explained that the FDIC’s withdrawal of its amicus brief filed last April is driven by leadership change. It’s a clear signal of support for the banking industry and a return to the FDIC's original position from 1992, the only other time the FDIC was involved in litigation related to this issue, Kim said.

The amicus brief was filed under former FDIC Chairman Martin Gruenberg. Travis Hill, the current FDIC head, laid out his priorities before he took office, advocating for a “more open-minded approach to innovation and technology adoption, including … a more transparent approach to fintech partnerships and to digital assets and tokenization.” Hill also highlighted his wish to “address growing technology costs for community banks.”

The FDIC's previous position, which Kim said was inconsistent with its past stance, led to criticism during oral arguments. The key dispute revolves around where a loan is “made” in the internet age. While Colorado argues that loans are made where the borrower is physically located, banks argue loans are made where the bank is located, and where employees, decision-making and fund disbursement originate, Kim noted.

“They took the pro-bank position back in 1992; so when they filed the amicus brief, they flip-flopped their position,” said Kim, representing all the state banking associations in the Colorado law case. “I think it's driven by leadership, but I just think that they're returning to their original position. It's not a new position.”

Phil Goldfeder, CEO of the American Fintech Council, lauded the FDIC for withdrawing the amicus brief, saying in a statement Monday, “restores longstanding guidelines and returns pragmatic, non-ideological policymaking to the FDIC.”

The law, which took effect July 1, 2024, counters the federal Depository Institutions Deregulation and Monetary Control Act of 1980, according to the National Association of Industrial Bankers, American Financial Services Association and American Fintech Council, who sued Colorado last March.

The banking trade groups won at the district court level, but Colorado has appealed to the Tenth Circuit. 

“We commend the agency for its common-sense approach to creating fairness and stability in lending, and look forward to working with Acting Chairman Hill on further solutions to create regulatory clarity for responsible lenders,” Goldfeder said in the statement.

Virginia legislation

On Monday, the same day the FDIC withdrew its amicus brief, the AFC sent a letter to Youngkin urging him to veto Senate Bill 1252 to preserve competition in the state’s financial services market and warning of the legislation’s restrictive nature.

Last year, AFC members provided about $800 million in credit to some 235,000 Virginia residents, the letter said.

The legislation also raises concerns for AFC regarding the burden on Virginia's Bureau of Financial Institutions to implement and enforce its requirements. 

“This bill lacks clarity on how responsible fintech companies and their bank partners can operate in Virginia, leading to costly implementation challenges for Virginia’s banking regulator, potential legal disputes, and a waste of government resources and Virginia taxpayer dollars,” Ian P. Moloney, AFC’s head of policy and regulatory affairs, said in a statement. “Rather than creating uncertainty, policymakers should focus on clear and consistent regulations that ensure consumer protection while allowing responsible lenders to serve the market.”

Virginia, for its part, is expanding its interest rate caps to cover two relatively new areas: adding anti-evasion measures to existing usury laws and covering comparatively newer financial products like earned wage access.

The “anti-evasion” provisions target banking-as-a-service and fintech-bank partnership programs where banks technically make the loans while the fintechs market and operationalize the loans. In most cases, the products are white-labeled under the fintech's name, Kim said.

With the provisions, Virginia is eyeing transactions disguised as asset purchases but functioning as loans, Kim noted. These loans would be treated as loans subject to the state's interest rate cap, which is 12% in Virginia.

Since banks’ and fintechs’ primary objective is to make money through a partnership, the 12% rate cap might be a hindrance and make Virginia a “less attractive state,” according to Kim. If the bill is passed, subprime borrowers may be excluded from loans since the better a person’s credit score, the lower the interest rate, he said.

“Super prime … or prime borrowers might get a loan because their interest rate is OK at 12% or less,” Kim said. But “nobody is going to lend money to a subprime borrower at 12% or less, on an unsecured loan.”