Federal Appeals Court Gives Colorado Authority to Apply Its Own Interest Rate Caps
A landmark ruling by a federal appeals court has granted Colorado the authority to apply its own interest rate restrictions on loans provided by state-chartered banks from the other 49 states to its residents. This decision could have far-reaching implications for bank-fintech partnerships, which often involve state-chartered banks extending loans at interest rates higher than those permitted by the states where the borrowers reside. The ruling may also result in national banks, exempt from state interest rate caps, becoming a more appealing choice for fintechs using bank partnerships for consumer loans.
The Implications of the Ruling
This ruling, met with mixed reactions, may initially affect only loans made to residents of Colorado, but both advocates and critics of high-cost consumer lending predict that its impact could eventually reverberate nationwide.
Phil Goldfeder, CEO of the American Fintech Council, voiced his disappointment in the ruling, stating, “If allowed to stand, it will only perpetuate a patchwork of state regulations that limits access to affordable, innovative credit products.” Meanwhile, Andrew Kushner, senior policy counsel at the Center for Responsible Lending, welcomed the decision, suggesting that other states may follow Colorado’s lead.
Interpreting a 45-Year-Old Federal Law
The 2-1 decision marked the first time that a federal appeals court has interpreted a long-overlooked provision of a 45-year-old federal law. The significance of this provision has grown in an era where consumer loans backed by bank-fintech partnerships have become increasingly common. The 1980 law allows states to opt-out of statutory language that previously granted state-chartered banks the same authority to set interest rates as national banks. In states that don’t opt-out, the law effectively allows state-chartered banks from the other 49 states to bypass interest rate caps.
In 2023, Colorado legislators chose to exercise the state’s opt-out right. The state’s laws restrict interest rates from 8% to 45%, depending on factors like the type and size of the loan. The court was then tasked with determining whether the new law applies only to Colorado-chartered banks or if banks from other states must also adhere to Colorado’s interest rate caps when lending to Coloradans.
The Court’s Interpretation
The court concluded that a loan from an out-of-state bank to a Colorado resident is considered “made in” Colorado. The judges stated that Colorado exercised its opt-out right due to proliferating “rent-a-bank” arrangements, where nonbank lenders partner with banks in states with high or no interest-rate caps, subsequently exporting high interest rates to states that would otherwise prohibit them under their own laws. The judges also noted that “the public interest counsels against enjoining a valid enacted law from a democratically elected state legislature.”
Future Implications
While the decision is likely to be appealed and is theoretically binding only in certain states that have not exercised their opt-out rights, it could inspire other states to follow in Colorado’s footsteps. The ruling has reinvigorated discussions around opt-out legislation in states like Rhode Island and Minnesota, and in Oregon, an opt-out bill passed the House of Representatives earlier this year before stalling in the Senate.
Industry groups, on the other hand, have criticized the ruling, arguing that it threatens to fragment financial and credit markets across the U.S. The National Association of Industrial Bankers, one of the trade groups that sued over the Colorado law, warned that it could usher in a confusing patchwork of state laws, making credit more expensive and less accessible nationwide.
Despite the criticism, the ruling could potentially lead to a shift in fintech partnerships from state-chartered banks to national banks, which are not subject to state interest rate caps, should the reasoning of the 10th Circuit hold up.
This landmark ruling underscores the ongoing tension between state and federal regulation of consumer lending and could have far-reaching implications for the future of the fintech industry. It will be interesting to see how it shapes the relationships between fintechs, banks, and consumers in the future.
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