When Benjamin Lawsky, New York State's Superintendent of Financial Services, sent a letter earlier this week to 35 online lenders, instructing them to "cease and desist" from offering loans that violate local usury laws, an interesting fact jumped out: several were Native American tribes or affiliated with tribes.
Consumer advocates are accusing some online lending firms of using Native American tribes as shields to skirt state rules, and regulators are listening.
"Companies are using claims of tribal immunity from state and federal laws to evade consumer protections," says Tom Feltner, director of financial services at the Consumer Federation of America. "We view this as a growing problem."
Feltner says a company will list a tribal disclosure but bury its alliance at the bottom of the website. "This poses several consumer challenges," Feltner says. "We are very concerned that today it is payday loans but it could be other financial services products down the road."
Banks are directly affected the New York State Department of Financial Services has asked banks to "choke off" ACH access to online lenders that charge interest rates that violate state limits.
The FDIC has weighed in on the matter. "Based on specific facts and issues, we may work collaboratively with other regulators and law enforcement as appropriate to ensure banks are effectively managing relationships with payment processors and higher-risk merchants, such as payday lenders," writes Andrew Gray, spokesman of the FDIC, to BTN.
"I think the writing is on the wall," said Alan Kaplinsky, partner at Ballard Spahr, in an e-mail to BTN. "Online lenders who fail to comply with applicable state laws in the borrowers' states are going to be under siege from not only state attorneys general and departments of banking but more importantly the Department of Justice, the Federal Trade Commission and the CFPB. By focusing on the banks that provide access to the ACH system, the Feds have figured out a potentially more effective way of dealing with the problem than bringing enforcement actions against hundreds of online payday lenders."
Kaplinsky adds that he does not think the regulators have any problem with the online payday lenders that comply with state laws in the borrowers' states.
Smaller short-term, high-interest loans, once the purview of storefront payday lenders, are increasingly obtained by people clicking a few buttons online or tapping their mobile devices to get quick access to funds.
The volume of online lending grew to $18.6 billion in 2012, according to data compiled by John Hecht, a research analyst at investment bank Stephens Inc. The growing shift to digital has caused a rift among the market's participants: originators are following different rules and regulation depending on, among other things, their physical location.
Certain states restrict the ways payday loan companies can issue their products, such as by limiting the amount of loans they can give to borrowers or setting interest rate caps; however, not every company is following them. One such group arguing exemption from the rules are Native American tribes, who have sovereign immunity and offer online lending to people across the country as a means to gain economic benefits.
The ongoing issue, which Attorneys General in the states of Colorado and Minnesota, among others, have focused on, has made its way slowly but surely into the courtroom. A magistrate court ruled in mid-July that the Federal Trade Commission has authority over payday lending companies, regardless of their tribal affiliations, and that all are subject to the Federal Trade Commission Act, the Truth in Lending Act and the Electronic Fund Transfer Act.
"The FTC is saying enough is enough," says Lawrence Kaplan, of counsel at Paul Hastings LLP. "It's a wakeup call."
The Native American Financial Services Association [NAFSA], an association formed in 2012 to advocate on behalf of and protect Native American sovereign rights, declined to speak to the recent ruling, telling Bank Technology News it's not its practice to comment on other organizations.
"We will say that our members are required to abide by a stringent set of best practices that ensure consumers can trust NAFSA members to honor their rights, protect their privacy, treat them fairly, and constantly strive to offer them innovative alternative financial products. We promote the utmost in transparency and rigorously enforce these practices to ensure our members are the best actors in the business," said Barry Brandon, executive director of NAFSA, in a statement to BTN.
On its website, the association highlights the rules tribes should consider as guidelines for best practices, including the Truth in Lending Act and Equal Credit Opportunity Act.
Tribal-affiliated lending is one of several areas of online lending getting added scrutiny from regulators. Consumer advocates are closely watching lead generation companies and offshore operations.
The Consumer Financial Protection Bureau continues to look at a wide range of payday lending issues that could harm consumers, including the growing presence of online payday loans. The Bureau has said federal consumer financial law applies to all payday loans.
The Online Lenders Alliance, which includes tribal lenders, is advocating for legislation that would create a federal charter that non-banks, including tribes, could opt to use. H.R. 1566, the Consumer Credit Access, Innovation and Modernization Act, would authorize the Comptroller of the Currency to create a federal charter for qualified nonbank lenders to operate as internet consumer credit corporations. As written, the bill prohibits loans of 30 days or less, or which require repayment in a single lump sum. State laws would still apply as long as they did not "significantly interfere with" the lending activities allowed by the legislation.
"Like all issues related to commerce on internet, the laws have not caught up to technology," says Peter Barden, spokesman for the Online Lenders Alliance.
Barden says consumers are clamoring for more credit options and points out that some of the recent FTC actions have been made against lenders who applied for association membership and were denied. "We work closely with the FTC," says Barden.
Why Tribes Play Along
The need for people to access cash quickly to pay for immediate financial concerns, like a flat tire or a medical bill, is pervasive and recognized by consumer advocates and lending associations alike.
"We know that consumers are looking outside of the traditional banking system for financial solutions, and those alternatives do a better job of meeting their needs. Online lending is only one of those alternatives," writes NAFSA's Brandon in an email to BTN.
And tribes need the revenue from such business, as many no longer make money off on-premises gambling.
"The biggest change in online lending in recent years has been the growth, prevalence, and increase in internet availability across the country. Many reservations are in incredibly rural and remote areas, which make gaming and tourism difficult or impossible," writes Brandon. "They don't have the numbers to drive sustainable economic growth, which has traditionally created cycles of poverty and dependence. The rise of the Internet and online lending has changed all of that and has begun to break this cycle. E-commerce is opening up the world to our members, and our tribes are finally starting to reap the economic benefits. They're seeing the ability to invest in their reservations, build better schools, and provide a secure economic future for their children. And it's all because of these tribally-owned businesses."
NAFSA declined to talk about individual customers, or whether or not online lending services are growing among its member base. The product itself is undergoing an underwriting technology transformation as alternative financial startups, including ZestFinance and Think Finance, have formed partnerships with tribal lenders.