The District of Columbia’s city council is weighing legislation that, if enacted, would “opt” the District out of pro-consumer lending provisions. If this sounds familiar, it’s because just a couple of months ago, Colorado was debating the same issue and ended up passing “opt-out” legislation that will go into effect July 1. If D.C. follows suit, consumers will suffer greatly as access to credit dries up.
The issue at hand is rooted in the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA). The act established rules for state and federal banks nationwide. Regarding interest rate caps on loans, the DIDMCA allowed for out-of-state, state-chartered banks to issue loans per the rate caps of the state where they were chartered, regardless of the customer’s residency. This meant that if a bank chartered in Georgia issued a loan with a 35 percent interest to a customer in Colorado with a 36 percent rate cap, that loan would still be permitted.
Under the DIDMCA, usury laws apply only to loans “made in” the state, not loans made outside the state. The crux of the issue comes down to how “made in” is defined, with the understanding that out-of-state chartered banks aren’t making loans in a state where a customer resides.
If “made in” refers to the origin of the loan, then banks chartered outside the state in question would not be subject to the state’s usury laws where their customers live. If “made in” refers to the destination of the loan, then all loans, no matter their origin, made to residents of the state must abide by its usury laws.
These provisions were laid out in sections 521-523 of the DIDMCA, but section 525 allowed states to “opt out” of these constraints. However, this has rarely been an issue in the past; only Iowa, Puerto Rico and now Colorado have elected to opt-out. With D.C. debating whether to follow suit, a trend may be forming that forces the courts to decide on the correct interpretation of section 521.
The Financial Tech (FinTech) angle becomes even more pronounced after considering how the DIDMCA relates to the Madden Fix, which allowed non-bank FinTechs to work with banks in partnerships that permitted interest rates to be set according to the bank’s chartered state. FinTechs were thus able to take advantage of favorable rates afforded to their banking partners, giving more consumers access to credit. The “fix” relied on the DIDMCA, and opting out could “un-fix” this beneficial accommodation. The Madden Fix has allowed for the proliferation of credit to consumers in need and is especially important as FinTech becomes more popular in the digital age.
Consumers benefit from a wider range of interest rates when taking out loans. Research by American Consumer Institute professor Thomas W. Miller Jr. reveals that rate caps don’t necessarily raise loan costs for most borrowers but instead result in fewer loans being issued to sub-prime consumers. Without access to legal loans, sub-prime borrowers may resort to loan sharks, like when usury laws were widespread.
The reason this occurs is simple: Interest on loans needs to make the issuer a profit. The higher the probability a borrower doesn’t pay back the loan, the higher the interest needs to be to justify the extension. This calculation does not fundamentally change when interest rates are capped. All that changes is the level of risk a creditor can take on when issuing a loan, cutting out the highest-risk clients who are often the most in need.
Though not yet passed, the D.C. legislation could continue the dangerous precedent set by Colorado and signal to other jurisdictions that “opting out” is feasible. Under the Constitution, Congress could intervene to block this bill from taking effect. Because this has only happened four times since the home rule was enacted in the 1970s, this seems unlikely.
Only time will tell if “opting out” will continue to snowball into the national spotlight. In the meantime, policymakers and their constituents should be aware of the dangerous reality of interest rate caps. Increased access to financial technology has created new opportunities for people who have never had them. By bringing back the old usury regimes of past decades, states are not only opting out of useful national standards but also progress and financial modernization.
