Predatory Lending: Pre-empting Predators

Federal regulators have some fancy tools and the Comptroller of the Currency plans to use his. The tool in question is federal preemption. The action is driven by the spate of state laws that are designed to protect vulnerable customers from predatory lenders. However many of the state laws do more than protect customers. They inhibit interstate commerce and the national banking system. So the Comptroller of the Currency is stepping in.

Protectionist anti-predatory laws may have the unintended effect of drying up credit in certain markets. When state laws restrict the terms on which credit may be offered and place severe penalties for violations, many lenders simply pack up and leave the market. Or lenders may stop offering the types of credit that are or may be subject to the restrictive state law. The result can be the opposite of CRA. People who need credit cannot obtain it.

The OCC is proposing a rule that would automatically preempt certain state laws. At the same time, the regulatory revisions would clearly prohibit predatory lending, as defined by the OCC. The justification for the proposed rule has two important purposes. The first is to protect the national banking system and enable national banks to exercise their full powers without state interference.

The second purpose is interesting. The OCC has concluded that banks are not, by and large, predatory lenders. Banks are also closely regulated so that any practices that could be considered predatory would be quickly identified by examiners. Based on this conclusion, the OCC believes that it will enhance the availability of credit, particularly non-predatory credit, to preempt the state laws on predatory lending.

The Comptroller is taking a strong stand in several respects. First, the OCC has now gone on record stating that national banks are for the most part not among the predatory lenders. Evidence that national banks are engaged in predatory lending is "scant." The OCC bases this statement on information (and the dearth of it) from third parties, the OCC's consumer complaint data base, and the OCC's supervisory activities.

Second, the OCC is essentially telling states not to interfere with the national banking system by restricting product terms and conditions. This is the OCC's turf and the OCC intends to protect it. This proposal amounts to a strong statement that the OCC, through its examination system and regulatory activities, is on top of this problem. It is also implicitly a statement that banks need some protection from the possibility of well-meant but potentially destructive involvement of other authorities.

The proposal would establish clearer standards that the OCC would use to make preemption determinations. It would leave states with the authority to make national banks subject to the legal framework of activities related to lending within a state (filing security interests, providing for property ownership) but would totally preempt the ability of states to limit the terms and types of products that national banks could offer.

The OCC supports and defends this seemingly aggressive position by pointing out that the national bank examination system has proven its ability to keep the lid on predatory lending. The OCC cites its enforcement actions (Providian, The Associates) and the strong stand it has taken in calling attention to practices that are considered predatory and directing national banks to avoid them. See, for example, Advisory Letters 2003-2 and 2003-3.

The proposal states that "national banks' real estate lending is pervasively regulated under Federal standards and subject to comprehensive supervision." It is not often that a regulatory agency uses terms such as "pervasive" and "comprehensive" to describe its work. The attitude of the OCC is clear in this proposal.

How it works
In several sections of the U.S. Code, the OCCs regulations provide for the authorities and powers of national banks. The OCC would expand those sections of the regulations to provide clearer guidance on the extent of regulation by the OCC, and therefore the territory which the states may not enter with respect to national banks.

A new Section 7.4007(b) would state: Except where made applicable by Federal law, state laws that obstruct, in whole or in part, or condition, a national bank's exercise of its Federally-authorized deposit-taking powers are not applicable to national banks." A similar provision with regard to lending would be in Section 7.4008(c).

Section 34, Real Estate Lending, would contain similar language together with a list of state powers, such as contracts, torts, homestead law, debt collection and similar issues that states may impose on national banks only to the extend that they incidentally affect the real estate lending powers of national banks.

The proposal also contains specific lending guidance. Underwriting to be based on the ability of the customer to repay the loan and not on the value at foreclosure of the property.

ACTION STEPS

Review your lending practices to be sure you don't slip into the territory of predatory lending.
Revise your loan policy to require documentation of underwriting, including income and debt ratios.
Review consumer complaints for issues that could become sensitive.