Clamping Down On Payday Loans, Cont’d. . .

January 27, 2014 at 9:12 am 4 comments

The extent to which states can block payday lending activities and the role financial institutions, including credit unions, should play in this effort continues to be an issue that is vexing regulators, law enforcement and the judiciary.

An article in this morning’s New York Times demonstrates why the issue is so confusing. On the one hand, it highlights how the Justice Department is targeting financial institutions as the choke point of payday lending activities. However, the same article shows that legislators, such as Darrell Issa of California, are critical of such efforts complaining that the Justice Department is trying to deter perfectly lawful lending activities. Who’s right and who’s wrong? The truth is that there is no definitive answer to either one of these questions and that how you answer it depends on where you live.

First, some basics. The Internet has made it incredibly easy to export financial products across state lines. New York, with its usury limits, has always effectively banned payday loans. However, federal law contains no such prohibitions as applied to banks. It has always been possible for a federal bank located in a state with no usury limit to offer payday lending options to New York State residents. However, the growth of the Internet has greatly expanded the marketplace for such offers.

There are two separate paths that have been taken to deter payday lending. One approach is to make financial institutions utilizing the ACH system more closely scrutinize payment requests coming from payday lenders. The other is to have the Court issue injunctions against payday lending activity.

Under the first approach, when a member enters into a payday lending agreement, these agreements typically include authorization for the lender to electronically pull money from the borrower’s account. Generally speaking, when an originator such as a payday lender originates such a payment request, the primary obligation to assess whether the payment is in fact authorized is on the institution with which the business has a banking relationship (the Originating Depository Financial Institution). Rules being proposed by NACHA would generally lower the threshold after which originators are obligated to further scrutinize such payment requests. On Friday, the FTC weighed in favoring NACHA’s approach.

But according to New York State’s Department of Financial Services, which has also commented on the proposal, NACHA’s proposal is a step in the right direction but does not go far enough. According to the Department evidence “that illegal payday lenders continue to use the ACH system to effectuate illegal transactions demonstrates that there are insufficient consequences for exceeding the return rate threshold. More effective enforcement of NACHA rules is necessary to prevent originators from engaging in illegal conduct through the ACH network.”

The problem is that what might be illegal to New York State’s Department of Financial Services is a perfectly legitimate business activity when viewed from the perspective of a Californian congressman. A federal district court judge in New York has ruled that the state has the authority to regulate payday lending activity when conducted over the Internet even when such activity is originated by a financial institution on an Indian Reservation. In contrast, California state courts have reached the exact opposite conclusion. A recent decision ruled that California’s financial regulator did not have the authority to impose fines on payday lenders controlled by Indian tribes. See People v. Miami Station Enterprises, 2d District, CA Court of Appeals (January 24, 2014).

If all this sounds confusing, it’s because it is. Ultimately, Congress or the Supreme Court, will have to decide if states have the ability to regulate payday lending and if so, under what conditions. The use of NACHA rules to regulate unseemly but arguably legal activity is destined to be an ineffective way of dealing with payday lending.

Entry filed under: Compliance, Legal Watch, New York State, Regulatory. Tags: , , , .

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Authored By:

Henry Meier, Esq., General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association.

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