When the Consumer Financial Protection Bureau (CFPB) opened for business, many rules and regulations traditionally handled by the Federal Reserve and other banking regulators transferred to CFPB control. The bureau also became the lead—but not sole—arbiter of what would constitute violations under UDAAP (Unfair, Deceptive, or Abusive Acts or Practices).
Before CFPB became fully functional, experts predicted that traditional banking regulators would not cede consumer protection to the newcomer agency. Just such a struggle has come to the fore over the matter of direct deposit advance programs. The scrimmage appears to be as much about perceived turf as about regulatory substance—only a comparative handful of large banks offer such short-term credit products.
The ranks of institutions offering them all but froze in place about a year ago, as both the bureau and other regulators began paying more attention to them. Deposit advance programs’ details vary, but the essential element is that borrowers explicitly request a loan tied to a deposit account into which they receive electronic direct deposits of salary, benefits, or other payments. The short-term loans typically are paid off from the next direct deposit, hence the name “deposit advance.”
“In general, with overdraft service, the depositor has made a mistake or was just sloppy,” says Virginia O’Neill, senior counsel II at ABA’s Regulatory Compliance Center. “With a deposit advance, you’re making a choice to advance money to yourself, from your future income.”
The products have become controversial, due to parallels seen by consumerists and regulations between their use and payday lending.
“The regulators don’t like the prices, nor do they like people’s repeated use of the programs,” says Nessa Feddis, deputy chief counsel at ABA’s compliance center.
CFPB Director Richard Cordray recently lumped both payday and deposit advance products together: “What we have found is that too often consumers are getting caught in a revolving door of debt. . . . [T]here is not much difference, from the consumer’s perspective, between payday loans and deposit advance loans.”
Who “owns” advances issue?
In late April, a white paper recounting the first stage of a long-term study by CFPB presented preliminary data and conclusions concerning payday loans and deposit advance products—though the document’s tone was anything but preliminary.
“It appears these products may work for some consumers for whom an expense needs to be deferred for a short period of time,” the bureau wrote in its conclusion. “The key for the product to work as structured, however, is a sufficient cash flow, which can be used to retire the debt within a short period of time. . . . However these products may become harmful for consumers when they are used to make up for chronic cash flow shortages. . . . In addition, the current repayment structure of payday loans and deposit advances, coupled with the absence of significant underwriting, likely contributes to the risk that some borrowers will find themselves caught in a cycle of high-cost borrowing over an extended period of time.”
The final section of the white paper states that the bureau intends to provide expanded consumer protections in both the payday loan and deposit advance areas.
Around the same time that the bureau published its report, FDIC and the Comptroller’s Office released proposed supervisory statements about deposit advance programs. They are essentially the same. (Comments closed on the two proposals on May 30.) The Federal Reserve issued a statement that did not agree with the FDIC and OCC position that these programs pose safety and soundness risk.
FDIC and OCC outlined numerous compliance and safety and soundness concerns about deposit advance programs. Under the proposals, examiners would review the programs’ credit quality and underwriting; capital adequacy; the bank’s reliance on fee income; the adequacy of the allowance for loan and lease losses; and compliance, management oversight, and third-party involvement in the services.
The two banking agencies stressed the need for lenders to be aware of the impact of advance credit programs and repayments on consumer well-being. The document calls for programs that would allow “the borrower to continue to meet typical recurring and other necessary expenses, such as food, housing, transportation, and healthcare, as well as other outstanding debt obligations. . . . without needing to borrow repeatedly.”
A feature of current advance programs is a “cooling off” period intended to prevent borrowers from piling on debt. Other limitations include lender cautions that deposit advance programs are intended as short-term, fee-based credits for urgent needs. (Critics of the programs use the short duration of the loans and the relatively high fees to produce annual percentage rate calculations that put advance programs in a bad light.)
The agencies state that: “Repetitive deposit advance borrowings indicate weak underwriting and will be criticized in the Report of Examination and then taken into account in an institution’s rating.”
In a highly unusual move, the agencies went beyond strict credit analysis in urging lenders to weigh the suitability of a consumer for deposit advance products by reviewing financial capacity, to include an analysis of the transaction patterns in the deposit account itself:
“An analysis of the customer’s account for recurring deposits (inflows) and checks/credit/customer withdrawals (outflows) over at least six consecutive months. Lines of credit of any sort, including overdrafts and drafts from savings, should not be considered inflows.”
Who’s the tougher cop?
Industry research has found that breakeven for a small consumer loan comes at around $2,500. Feddis points out that the loan levels made during FDIC’s pilot program were much smaller, and many of the banks involved found they could not make a profit on loans of that size due to high fixed costs. At best they found that such small loans could help preserve profitable overall banking relationships, she adds—plus community good will.
O’Neill says the Comptroller’s earlier proposed guidance on advance programs—part of an inclusive 2011 document that attempted to deal with all deposit-related credit—dissuaded new banking entrants. “Nobody would get into it while that proposal was out there, and now that will continue,” says O’Neill. “That is a bad thing, because they are discouraging innovation in the market for short-term credit.”
“And this raises the question,” says Feddis: “Are the regulators and CFPB really just creating a ‘vanilla product’ template? That’s something that Congress rejected when it was putting the parts of Dodd-Frank together that created CFPB.”
Feddis says it is paradoxical that while the bureau, on one hand, is encouraging innovation through Project Catalyst, “regulators are saying that anyone that takes a risk with anything new may be held responsible for UDAAP violations and all sorts of other threats.”
Feddis says banks making advance loans have told her that even when they impose a cooling off period, their customers frequently then tap payday lenders. Going by the details of the part of the proposal dealing with deposit flow monitoring, says Feddis, would require the banks to drop these customers—“which would then mean that they could only go to payday lenders.”
But what both attorneys object to the most about the advance debate is the number of players involved.
“The justification for the bureau was supposed to be that there would be a single regulator, a single rule, and a level playing field across not only banking, but among all players, product by product,” says Feddis. “And here we’ve got a perfect illustration of why that’s not the case.”
“We have a CFPB now,” says O’Neill, “and so that means that OCC and FDIC ought to defer to the bureau’s lead on consumer protection issues—and they haven’t. Instead we have regulatory one-upmanship, with FDIC and OCC all too eager to demonstrate they are interested in protecting consumers, too.”
Where will people borrow?
Feddis believes deposit advance service suffers from stereotyping—being seen as a product utilized by the poor. Yet she points out, according to the bureau, the average annual deposit (after tax, Social Security, and other deductions) of users of payday and direct deposit advance loans is on average about $43,000. The median is $36,000.
“It’s not necessarily low-income people using these loans,” says Feddis. “The users of advance services have their challenges, and they have a different way of managing their finances, and it can be a challenge to find out what product suits them.” What separates a deposit advance from a cash advance on a credit card is the expectation that the deposit advance will be repaid in full with the next direct deposit.
Feddis sees FDIC contradicting itself. On the one hand, in existing guidance on small-dollar loans, “they say that documenting the borrower’s ability to pay could be streamlined significantly for existing customers—perhaps as little as providing proof of recurring income.” On the other hand, she says, in the deposit advance proposal, “they’re saying that it’s outrageous and unacceptable that banks have only been looking at proof of recurring income. They are saying that that’s a weakness in underwriting.”
She adds that the requirement to monitor deposits “could be intrusive and offensive to customers.”
“The bottom line is that FDIC and OCC are bowing to consumer group pressure,” says O’Neill. “Consumer advocates hate this product. So far no one has presented evidence that consumers who use the product share that sentiment. We fear that the proposed guidance will make consumers less well-off as it will limit access to short-term credit.” Many have already been pushed out of credit cards by 2009 card legislation.
“Not one consumer who used product payday loan had anything negative to say” during field hearings about advance programs and payday loans, says Feddis.
“So if you squeeze out direct deposit advances and squeeze out payday loans, where are people going to go?” says O’Neill. “They’ll go back to the pawn shops or to the online lenders—or the guy in the alley. The ‘shadow banking system.’”
“That demand will not go away,” adds Feddis.