Alston & Bird Consumer Finance Blog

#OCC

OCC Issues Guidance on “Buy Now, Pay Later” Lending

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A&B Abstract:

On December 6, 2023, the Office of the Comptroller of the Currency (OCC) issued a bulletin aimed at providing guidance to national banks and federal savings associations (“Financial Institutions”) involved in “buy now, pay later” (BNPL) lending. The advisory emphasizes the need for these Financial Institutions to carefully manage risks associated with BNPL, focusing on aspects such as underwriting, repayment terms, pricing, and safeguards to protect customers. Additionally, the OCC stresses the importance of clear and prominent marketing materials and disclosures.

The Bulletin

While BNPL products may vary, the bulletin focuses on BNPL loans which involve four or fewer installments without finance charges, and that are commonly offered at the point of sale. Such BNPL products are distinguished from more traditional installment loans with payment terms greater than four installments or that charge interest or carry other finance charges. These loans have become increasingly popular, especially among younger individuals and those with limited credit history.

The OCC identifies various risks related to BNPL loans for both lenders and consumers, including credit, compliance, operational, strategic, and reputational risks. Specific concerns include potential borrower overextension, limited applicant credit history, unclear disclosure language, challenges with merchandise returns and merchant disputes, operational and compliance risks related to third-party relationships, and increased operational risk due to the highly automated nature of BNPL lending.

Further details on risks include the potential for elevated first payment default risk, additional fees for borrowers due to overextension, and the possibility that credit reporting agencies may lack visibility into BNPL activity.

The OCC’s guidance advises Financial Institutions engaged in BNPL lending to establish robust risk management systems, including prudent lending policies for risk identification, measurement, monitoring, and control. Regarding credit risk, the bulletin emphasizes the importance of sound charge-off practices, allowances for credit losses, and timely reporting of comprehensive information to credit bureaus under the Fair Credit Reporting Act.

The guidance also provides recommendations for operational risk management. It encourages Financial Institutions to assess and mitigate fraud risks, subject BNPL lending process models to sound model risk management and integrate BNPL lending into broader compliance management systems. Additionally, it highlights the need for Financial Institutions engaging third parties in BNPL lending to incorporate such relationships into their third-party risk management protocols.

Takeaway:

Given the OCC’s focus on the risks associated with BNPL products, now is a good time for Financial Institutions engaged in BNPL Lending to ensure that their compliance management programs are robust enough to ensure compliance with the OCC’s guidance.

OCC Rule Affirms Valid-When-Made Doctrine

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A&B ABstract:

On May 15, the Office of the Comptroller of the Currency  (“OCC”) issued a final rule, effective August 3, 2020, addressing the “valid-when-made” doctrine.  The rule clarifies that the interest rate on a loan originated by a national bank or federal savings association, if permissible at the time of origination, will continue to be a permissible and enforceable term of the loan following a sale, transfer, or assignment of the loan, regardless of whether the third party debt buyer is a federally chartered bank.

Discussion

In November, 2019 the OCC issued a proposed rule to address the ambiguity created by the Second Circuit in Madden v. Midland Funding, LLC. The Madden court held that a purchaser of a loan (unsecured credit card debt) originated by a national bank could not charge interest at the rate permissible for the bank if that rate would not be permissible under the applicable state usury cap. Madden did not address the valid-when-made doctrine, and the U.S. Supreme Court declined to hear the case in 2016.

Final Rule

The OCC’s final rule, effective August 3, 2020, effectively codifies the valid-when-made doctrine.  Specifically, the rule provides that interest on a loan that is permissible pursuant to section 85 (applicable to national banks) and section 1463(g) (applicable to federally chartered thrifts) of the National Bank Act “shall not be affected by the sale, assignment or other transfer of the loan.” The OCC emphasized that “that sections 85 and 1463(g) incorporate, rather than eliminate, these state caps.”  A bank must comply with the interest rate limit established under the law of the state where it is located. The OCC recognized that disparities between interest rates between banks arise as a result of the state laws that impose such caps.

In affirming the valid-when-made doctrine, the OCC indicated that “to effectively assign a loan contract and allow the assignee to step into the shoes of the national bank assignor, a permissible interest term must remain permissible and enforceable notwithstanding the assignment”.  Further, the OCC, in rebutting comments made during the rulemaking that a third party non-bank debt buyer should not step into the shoes of the national bank originator, observed that “the enforceability of an assigned interest term should [not] depend on the licensing status of the assignor or assignee.”  Simply put, the OCC affirmed that when a bank transfers a loan, interest permissible before the transfer continues to be permissible after the transfer.

The rule does not address which entity is the true lender when a bank transfers a loan to a third party. The OCC’s rule applies to “interest,” as that term is defined in 12 C.F.R. §§ 7.4001(a) and 160.110(a).

Takeaways

The rule is welcome news, ensuring that uncertainty concerning the effects of the Madden decision does not erode the liquidity of the secondary market for loans originated by national banks and federally chartered thrifts.  It effectively levels the playing field by allowing purchasers of these loans to collect the same agreed upon interest rate and contractual loan terms as the original. Such uniformity is critical for the secondary market.  Hopefully, the FDIC will similarly finalize its proposed rule.

Nevertheless, we note that the OCC rulemaking does not reverse Madden, and while the pronouncement should be influential in circuits aside from the Second Circuit, it is expected to face court challenges, not to mention criticism from congressional Democrats.   The saga will likely continue.