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Bankers Hesitate on Higher Rates.

'Friendly' Lawsuit Should Clarify Law on Usury

ARKANSAS BANKERS' fondest fantasy finally came true with Congress' enactment last year of the Financial Modernization Act, yet lenders are hesitant to step out and take advantage of the new-found freedom.

The federal legislation contained a provision removing the last vestiges of the state's 125-year-old usury law. The new law affects more than 150 banks and savings and loans in Arkansas.

"I don't know of any banks loaning above the [usury] line, but a lot of people are looking at it," says Dan Bailey, executive director of the Arkansas Bankers Association. "They're assessing the business risk to doing so."

The herd of Arkansas-based banks are gun-shy about changing the old way of doing business because of concerns with possible judicial review.

"There will be a friend-of-the-court case to solidify the language of the law to make sure it is what everyone thinks it is, to make sure the courts interpret it the way bankers are," says Lunsford Bridges, president and chief executive officer of Metropolitan National Bank in Little Rock.

"That should be taking place right away. We feel confident it will be upheld. But ho one wants to make a bunch of loans to find out the courts interpret the loans as usurious."

That's what happened to one facet of Amendment 60 in 1983, which modified the state usury law. It initially was envisioned to remove the 10 percent interest ceiling at the wholesale loan level and create a floating ceiling of five percentage points above the federal discount rate at the retail loan level.

"The language of the draft was poor enough to be challenged, successfully," recalls Bill Bowen, former chief executive officer of Little Rock's First Commercial Corp. "The ruling struck down the 17 percent [wholesale] rare and left standing the 5 percent rate for both."

While conceding the likelihood of an unfavorable ruling is slim to none regarding the new federal law, bankers still want to have a court ruling in hand to ensure that judicial interpretation concurs with legislative intent.

"The issue will be a federal law overriding a state law, and there are many precedents [for that]," Bailey says. "[An unfavorable ruling] is a very small possibility, but until the courts actually say that, you can't say the possibility is zero."

Expectations are the test case will be filed in both federal and state course to speed up the process. The dual filing will head off any potential delays from questions concerning which court is the proper venue.

The roles of the friendly borrower suing the friendly banker to tie up this perceived loose end have yet to he cast. If the case produces its expected result, bankers are expected to sally forth with free-marker interest rates.

"Then we will evaluate on how we want to offer additional credit," Bridges says. "It will broaden the base to whom we can lend. It will be nothing but positive for the consumer."

Instead of some would-be borrowers having to go out of state to borrow money or being unable to borrow at all, they will have more instate options.

Arkansas-based banks will be able to compete on a level playing field with interstate banks that operate branches in the state. Institutions such as Bank of America and Regions Financial Corp. weren't subject to the Arkansas usury law because of federal laws governing interstate banking.

Bailey estimates that abut 40 percent of all branch locations in Arkansas are owned by interstate concerns.

"I would guess that about 90 percent or more of the credit extended in Arkansas is now governed by federal law," he says.

The only lenders still under the usury umbrella would be businesses such as furniture stores or car dealers that originate their own loans to finance sales. Many of these businesses already work through out-of-state lenders to bypass the state's usury restrictions.

Credit Unions Unaffected

The Financial Modernization Act will have little impact on the Arkansas family of credit unions. Most are already governed by federal laws that supersede the state usury limit.

"The usury law has never had an effect on us, except a good one," says H.C. Klein president of the state's largest credit union, Arkansas Federal Credit Union in Jacksonville.

"It's brought us a lot of business because banks tend to charge up to the usury limit. That's been the mindset in this state. Eventually, the market will set the rates, but I don't know how long it will take."

The Little Rock Municipal Water Works Credit Union and Arkansas Western Employees Credit Union in Fayetteville are the only remaining state-chartered credit unions, according to the Arkansas Securities Department.

All others converted to federal charters to take advantage of the less restrictive federal guidelines. No Arkansas lawsuits resulted to challenge this federal override dating back to 1982.

The Financial Modernization Act will give Arkansas banks the flexibility to offer higher rates to higher risk borrowers, which should in turn result in even lower rates for lower risk borrowers.

Usury laws were envisioned to protect consumers from interest gouging lenders. It also socialized loans because it restricted the parameters for risk-based pricing.

"We've seen from history that price controls simply don't work," Bailey says. "The market does work. Market rates tend to be below the stare's usury ceiling of the federal discount rate plus 5 percent."

Wal-Mart Left Out

While bankers espouse the free-market-rules dogma, holdovers of protectionist legislation still exist. In fact, one was created as part of the Financial Modernization Act that had a specific Arkansas company in mind.

Wal-Mart Stores Inc. had applied for regulatory approval to acquire a one-thrift holding company, which would allow it to get in the banking business. Bankers rallied to change the law, fearful of what the Bentonville-based retailing giant might do in the way of competition.

For bankers, the prospect of Wal-Mart entering the financial sector created unsettling visions of the everyday low-price doctrine showing up in a nationwide network of branches in Sam's Clubs and Wal-Marts.

"Within the banking community, there was a concern with creating such a large competitor in such a short amount of time," Bailey says.

"From what I've read, bankers said, 'We've got to pass this legislation or Wal-Mart is going to ear our lunch,'" Klein says. "In my mind, this is what caused the bankers to come together [on usury and other aspects of the Financial Modernization Act]. They've been fighting over this big banks versus little banks for years."

If Klein is correct in his observation, Wal-Mart unwittingly produced a meeting of the minds regarding free enterprise in a sector some be lieve was long overdue.

What the New Law Says

Gramm-Leach-Bliley Act of 1999 (Financial Services Modernization Act of 1999)

Section 731 Interest Rates And Other Charges At Interstate Branches

"In the case of any State that has a constitutional provision that sets a maximum lawful annual percentage rate of interest on any contract at not more than 5 percent above the discount rate for 90-day commercial paper in effect at the Federal reserve bank for the Federal reserve district in which such State is located, except as provided in paragraph (2), upon the establishment in such State of a branch of any out-of State insured depository institution in such State under this section, the maximum interest rate or amount of interest, discount points, finance charges, or other similar charges that may be charged, taken, received, or reserved from time to time in any loan or discount made or upon any note, bill of exchange, financing transaction, or other evidence of debt by any insured depository institution whose home State is such State shall be equal to not more than the greater of

"(A) the maximum interest rate or amount of interest, discount points, finance charges, or other similar charges that may be charged, taken, received, or reserved in a similar transaction under the constitution, statutory, or other laws of the home State of the out-of-State insured depository institution establishing any such branch, without reference to this section, as such maximum interest rate or amount of interest may change from time to time; or

"(B) the maximum rate or amount of interest, discount points, finance charges, or other similar charges that may be charged, taken, received, or reserved in a similar transaction by a State insured depository institution chartered under the laws of such State or a national bank or Federal savings association whose main office is located in such State without reference to this section.
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Publication:Arkansas Business
Article Type:Industry Overview
Geographic Code:1U7AR
Date:Jan 17, 2000
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