Preemption and Predatory Lending

The OCC has issued a final rule to preempt state laws that have the effect of limiting the powers of national banks. The regulation and the accompanying Federal Register document lay out the OCC's turf claim.

While most of the attention given to this regulatory proposal and action has been directed at the questions of preemption and the powers of states to protect citizens, the most significant thing is that this regulation has gone virtually unnoticed. The final regulation, like the proposal, contains an anti-predatory lending standard that has enormous implications for safety and soundness. In particular, it defines a safe and sound loan and, by doing so in this context, sets a standard for compliance issues of predatory lending and fairness in lending.

The Preemption Issue
We'll take this on first because it has gotten all the attention. The objection to OCC preemption of state laws prohibiting predatory lending has been more emotional than factual. Most of the objections have raised concerns that states will not be able to protect their citizens from predatory lenders in a consistent way.

Of course, the flip side of this concern is the basis of the OCC's argument: that the OCC is able to establish a national standard that banks doing business in multiple states and regions can follow.

Arguing against OCC preemption was a losing proposition from the beginning. The OCC's position is based on a decades-old series of court decisions. For anyone who likes heavy reading, there is a long - ancient, in fact - line of cases that clarify and uphold the national bank preemption issue. All the OCC has done is codify these decisions into a regulation. There is little or no change here - just the prospect of less litigation about the issue each time a state passes a law.

The position is that federal law authorizes the OCC to issue rules that preempt state law in the process of ensuring that national banks are able to operate to the full extent authorized under federal law. The bottom line is that national banks look primarily if not exclusively to the OCC for lending powers and standards.

How Preemption Works
The OCC, through this rule, is codifying its power and responsibility to issue rules that authorize national banks to act and that require national banks to act in a safe and sound manner. In so doing, the OCC reiterates the standard that the OCC is the sole rule making authority for national banks.

The original idea behind national banks, and later the federal savings and loans, was to create a national banking system thus making the banks' products and services consistently available throughout the nation. The argument is that specific state laws that reshape or limit national bank products are preempted by Congress' creation of the national banking system.

Under this approach, the federal laws that provide the institution's powers for lending and other banking services pre-empt any state law that limits these powers. However, federally chartered institutions do business in the context of state laws which govern such issues as property ownership, property transfers, and the like.

The Meat of the Matter
The new rule contains a provision that prohibits making loans to consumers based on the foreclosure value of the collateral without regard to the borrower's ability to repay. The standard applies across the full array of consumer lending.

A related rule prohibits national banks from engaging in practices that are unfair or deceptive. The unfairness and deception standards are set by the Federal Trade Commission through its rulemaking, interpretations and enforcement actions.

The safety and soundness standard is the revolutionary rule - for several reasons. Documentation has been a mantra in the world of fair lending for some time. Investigators of discrimination cases want to know what the customer asked for, what they were told, what the lender did or didn't consider, and then compare these with the results. The investigator can't do this without documentation in the file. Otherwise, the findings are mostly guesswork.

Then we have HMDA and CRA reporting requirements. Without information such as the applicant's income and some fairly basic information about the loan, the data reports are flawed. The ability to generate accurate reports relies on documentation. In particular, CRA data reports miss loans without documentation of critical information such as the borrower's income.

Predatory lending concerns have changed how all lending practices are being looked at. This preemption rule establishes a standard for fair, non-predatory lending. It provides a benchmark for unfair lending. Even more important, it establishes a documentation standard. There is only one way to demonstrate that the loan decision was based on the borrower's ability to repay rather than on the foreclosure value of the collateral and that is to document the borrower's ability to repay.

As already indicated by the proposal to revise the CRA regulation, this standard put forward by the OCC is likely to become the standard industry-wide. The question of whether of not a financial institution has the powers to provide certain loan products will be decided by state or federal law, depending on the institution's charter. But the standard for responsible lending, as distinguished from abusive lending, is being set by the Comptroller of the Currency.

ACTION STEPS

Review the lending policy and procedures for all types of loans to consumers. If you don't find the requirement to evaluate and document the borrower's ability to repay without reliance on the value of the collateral, start beefing them up.
Review training materials used for lenders. Look for explanations of evaluating ability to repay. If it isn't there, see to it that it becomes part of training.
Audit a sample of files for the types of consumer loans your institution makes. Look for adequate documentation of the borrower's ability to repay.
Review the loan products offered by your institutions and by any affiliates. Consider each product in the context of abusive lending standards. If you have concerns, don't delay - deal with them now.