The purpose of this blog is to respond to questions we have received as to why a state like Colorado would ever use Section 525 of DIDMCA to opt out of Section 521 of DIDMCA if it would not preclude rate exportation by out-of-state, state-chartered banks. The question suggests that Congress would not have enacted Section 525 for any purpose other than to prevent rate exportation. (This blog will not focus on the plain meaning of Section 525 since these arguments have been made in numerous briefs and previous blog posts.)
The simple answer is grounded in Congress’ purpose for enacting DIDMCA Sections 521 and 525 in March of 1980. That purpose had nothing to do with rate exportation—contrary to what the Colorado legislature apparently believed.
Congress’ purpose for enacting DIDMCA Sections 521 and 525 is best understood in historical context, supported by legislative history. In the period leading up to DIDMCA’s enactment, the prime rate of interest that banks charged to their most creditworthy customers was 19.5%. More importantly, the Federal Reserve Discount Rate was 13% (with a 3% emergency surcharge raising it to 16% for large frequent borrowers). In states with restrictive usury laws, banks’ cost of funds often exceeded the rates state banks could lawfully charge on loans. National banks were less impacted, however, because under Section 85 of the National Bank Act, they could charge up to 1% in excess of the prevailing Federal Reserve Discount rate (often referred to as the “Alternative Rate”), or the highest rate allowed by the state where they were located.
Now, let’s consider the legislative history of Sections 521 and 525. The major proponents of Section 521 were Senators Bumpers and Pryor of Arkansas. Why is that? It’s because Arkansas then had a 10% constitutional usury ceiling. Therefore, in Arkansas, national banks could use their Alternative Rate authority to profitably make loans at 14-17%, but their state bank counterparts would lose money on nearly every loan they booked. Credit availability dried up in Arkansas, particularly in rural areas, since national banks were mostly located in larger cities. Moreover, state banks could not retain deposits because their national bank counterparts could afford to pay more since they could lend out money at the Alternative Rate. Unlike other states with restrictive usury laws, Arkansas could not amend its constitution quickly enough to save their state banks from failure—assuming such an amendment could even pass a popular vote.
Arkansas officials asked Congress to help, which it did through the enactment of 521 which also permitted state banks to charge 1% over the Federal Reserve Discount Rate.
In order to appease lawmakers who philosophically didn’t like the idea of the Federal Government overriding state usury laws, Section 525 was enacted to allow states to opt-out of Section 521. As you can see, however, Congress’ focus was exclusively on intrastate lending. There was nary a mention of interstate lending or the 1978 Supreme Court Marquette case which authorized national banks to export the interest rate permitted by their home states to borrowers residing elsewhere. That is not at all surprising since there was very little interstate lending by state banks before DIDMCA because they did not acquire federal exportation powers until DIDMCA was enacted. Interstate lending by state banks was simply not the issue which Congress was seeking to solve through the enactment of Section 521.
It is true that the Alternative Rate under Section 85 of the National Bank Act and Section 521 of DIDMCA has not been used in recent times as usury authority by any banks making loans because the Federal Reserve Discount Rate is currently only 3.75% to 4.25%. Instead, national banks and state banks use the main usury authority in Section 85 and Section 521—the right to charge the interest rate allowed to state banks or any other lenders located in the same state. This is referred to as the “most favored lender doctrine.” For example, if consumer finance companies in a particular state are allowed to charge interest at 36% per annum for certain loans, national and state banks in that same state can also charge 36% per annum for the same kinds of loans.
The reason so many states that originally opted out ended up opting back in and so few states are now opted out (Iowa, Puerto Rico, Colorado and Oregon) is that it has long been commonly understood that (a) an opt out does not empower the opt out state to regulate the interest rates charged by out of state banks; and (b) an opt-out harms the state banks in the opt out state with respect to their intrastate loans to their residents and/or interstate loans to residents of other states. The states that initially opted out but later repealed their opt out statutes often did that when they recognized that they were putting their state banks at a major competitive disadvantage with banks located in states like Delaware and South Dakota which had not opted out of DIDMCA because of their desire to become a hub for interstate lending.