The government is imposing tougher restrictions on banks that offer short-term, high-interest loans that have been blamed for trapping some Americans in a cycle of debt.
On Thursday, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. issued identical guidance to limit the risks of loans tied to consumers’ paychecks, government benefits or other income directly deposited into their bank accounts.
Critics say these products carry the same abusive high interest rates and balloon payments as the payday loans offered by storefront and online operators. But industry groups contend that placing strict constraints on banks will only push people with limited access to credit into the arms of less-regulated vendors.
“The OCC encourages banks to offer responsible products that meet the small-dollar credit needs of customers,” Comptroller of the Currency Thomas J. Curry said in a statement. “However, deposit advance products . . . pose significant safety and soundness and consumer protection risks.”
Curry said the guidance is meant to clarify the agency’s expectations for banks to understand and manage those risks. Neither the OCC nor the FDIC will bar banks from deposit-advance loans, but their policies could radically alter the operations of the handful of banks that offer the product.
At least 15 states have already banned the service, while several others have imposed strict laws to limit the interest rates and the number of loans that can be made. Federal regulators are taking cues from state authorities proposing similar limits, including a “cooling-off period” that prevents borrowers from taking more than one deposit advance during a monthly pay cycle.
Another key concern is that banks determine a customer’s ability to repay before making a loan, a standard underwriting practice in all other types of lending. Regulators recommended reviewing at least six months of customer’s banking activities. If a customer’s account is routinely overdrawn, banks should hold off on extending credit, the agencies say.
Only six major banks offer direct-deposit loans: Wells Fargo, U.S. Bancorp, Regions Bank, Fifth Third Bank, Guaranty Bank and Bank of Oklahoma. But the scope of Thursday’s guidance is limited because Fifth Third and Regions are regulated by the Federal Reserve, which is not participating in the effort. The Fed did warn banks of the consumer risks posed by the products in April, but consumer advocates fear the warning is not enough.
“All banks should take this opportunity to find affordable ways to offer small-dollar loans,” said Lauren Saunders, managing attorney at the National Consumer Law Center. “Banks’ so-called ‘deposit advance’ loans are payday loans plain and simple.”
Banks market these products, with names such as “Early Access” or “Ready Advance,” as short-term solutions for financial emergencies. But borrowers often wind up taking multiple loans that keep them mired in debt.
Account holders typically pay up to $10 for every $100 borrowed, with the understanding that the loan will be repaid with their next direct deposit. If the deposited funds are not enough to cover the loan, the bank takes whatever money comes in, then tacks on overdraft fees and additional interest.
A study from the Consumer Financial Protection Bureau found that more than half of directdeposit borrowers took out advances totaling $3,000 or more. Of these borrowers, well over half paid off one loan and went back for another within 12 days. The average borrower took out 10 loans in a year and paid $458 in fees.
The CFPB has supervisory and enforcement authority for storefront and bank payday lenders with more than $10 billion in assets. Advocacy groups are eager for the bureau to write new rules to govern the industry, but the agency has yet to offer a firm timeline on rulemaking. The bureau took its first enforcement action against a payday lender on Wednesday, with a $19 million settlement with Cash America.
Proponents of payday and other alternative financial products caution against using broad strokes to define the industry.
“The restrictive measures in the guidance single out deposit advances but not overdraft or other comparable products, even though consumers use them similarly and interchangeably,” said Amy Cantu, a spokesperson for the Community Financial Services Association of America, an industry trade group. “When similar services are treated consistently, competition and transparency rule the day, driving costs to the lowest point and providing the greatest benefit to consumers.”
The guidance is modeled after rules the OCC issued in 2000 that barred banks from engaging in direct payday lending. Banks circumvented that guidance by tying their short-term loans to direct deposits.
Officials at Wells Fargo, the largest bank offering this type of loan, have said it is a vital service designed to help customers with unforeseen financial emergencies, such as car repairs.
The bank, which debuted the product in 1994, allows customers to spread out repayment through an installment plan, avoiding the balloon payments that hamstring some consumers. But the installment plan is offered only to people with at least $300 in outstanding debt who have been hit with balloon payments for three consecutive months. Company spokesperson Richele Messick declined to comment on the new guidance, saying the company is still reviewing it.