A new law will make Colorado a much more difficult place for cash-strapped citizens to get credit. Other states should avoid following in its footsteps, writes Todd Zywicki.
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The credit card you used to purchase your latte this morning and to fill your car with gas was probably issued by a bank based in Delaware, South Dakota or some state other than Colorado. Why? Because under a unanimous 1978 decision authored by liberal lion William Brennan, the Supreme Court ruled that banks holding a "national charter" would be governed by the interest rate ceilings of the state in which the bank is based instead of the state of the customer's residence. This one decision transformed the American economy, unleashingunprecedented competition and putting Visa, Mastercard and other credit cards in the hands of millions of American families who were previously reliant on pawnbrokers, personal finance companies and store credit to make ends meet.
Yet a law set to go into effect in Colorado in July would deprive the most credit-deprived Coloradans of the same access to competitive financial services available to the more well-off and effectively destroy the rapidly growing fintech industry in the state. The consequences to Colorado's more financially strapped households could be catastrophic. Other states are considering following suit.
The mechanism for this folly is a law enacted this past June under which Colorado will "opt-out" of an obscure federal law, the Depository Institutions and Monetary Control Act of 1980 (known as DIDMCA or DIDA), that was passed in response to the Supreme Court's 1978 decision. DIDA provided that banks chartered under state law would have the same rights to "export" their home state interest rates as national banks, in effect enabling state-chartered banks to compete on equal terms with national-chartered behemoths such as Citi and Chase. But DIDA also authorized states to pass laws to "opt-out" of this parity provision, thereby depriving residents of access to financial products issued by state-chartered banks based in other states. To date, only Iowa and Puerto Rico have invoked DIDA's opt-out provision, but other states and the District of Columbia currently are considering following Colorado down this path.
National banks would not be impacted by opting out of DIDA, thereby leaving their middle-class credit card users largely unscathed. Less well-off consumers, however, will be hit hard by the law. Banks traditionally have shown little interest in offering financial services to higher-risk and lower-income consumers, a problem that has been exacerbated in recent years by multiple financial regulations that reduce the incentives of large banks to serve these customers. Lacking access to credit cards, younger consumers, immigrants and others with unproven or poor credit rely on an assortment of financial products to make ends meet, such as installment loans, payday loans and pawn shops.
But in 2010, Colorado adopted a law that targeted short-term "payday loans," then in 2018 voters adopted a referendum that prohibited lenders from charging more than 36% for any loan, effectively wiping out the payday loan industry in the state. According to a report commissioned by the Colorado attorney general, access to small-dollar credit for consumers has collapsed since the referendum's passage, especially for borrowers with weaker credit, and competition has fallen dramatically. Recent experiments with lending price controls in New Mexico and Illinois show the same results of reducing access to credit. In Iowa, the only previous state to combine strict interest-rate caps with DIDA's opt-out, a mere 0.16% of residents were able to obtain small-dollar loans, a tiny fraction of those in less-regulated states such as Missouri where over 5% of borrowers obtained small-dollar loans.
The explosion in fintech services in recent years has been a savior for these traditionally underserved consumers. Fintech companies have demonstrated a propensity to reach customers traditionally ignored by big banks and have increased competition and choices available to those consumers. Unlike the massive national banks that dominate credit issuance, however, fintech providers often partner with smaller, more nimble state-chartered banks, such as Utah's WebBank or New Jersey's Cross River bank. According to a recent study by Federal Reserve economists Gregory Elliehausen and Simon Hannon, fintech partners of state-chartered banks have proven particularly beneficial to the most hard-pressed consumers ignored by mainstream banks and for whom traditional finance companies are unable to serve because of repressive interest rate ceilings.
By opting-out of DIDA, Colorado's politicians would complete its one-two punch to thegut of hard-pressed families by combining interest rate ceilings that effectively outlaw traditional small-dollar lending with the DIDA opt-out that shuts off fintech options offered in partnership with state banks as a life raft.
In a period of inflation and escalating housing and food prices, now is not the time to cut the final lifeline many Coloradans count on to make ends meet. Eliminating the supply of small-dollar credit doesn't eliminate the demand — restrictions on small-dollar credit have made it more difficult for consumers to pay their bills while forcing them to turn to less-preferred and more-expensive options such as pawnshops and bank overdraft protection. If Colorado's scheme is emulated by other states, many state-chartered banks will have incentives to recharter as national banks, effectively ending America's unique "dual-banking" system. The state should roll back its DIDA opt-out law before it goes into effect and give working-class Coloradans the same access to innovative and competitive choices as the well-to-do.
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