Operation Choke Point Won't Go Away Quietly

The Justice Department program Operation Choke Point set a dangerous precedent by pushing banks to sever relationships with lawful businesses. Now the Federal Deposit Insurance Corp. is taking important steps to undo the damage — but some people apparently haven’t gotten the memo.

The FDIC issued a financial institutions letter in late January encouraging banks to manage their risks on a customer-by-customer basis rather than by grouping entire industries according to "reputational risk." The effort, spearheaded by FDIC chairman Martin Gruenberg and vice chairman Thomas Hoenig, was accompanied by an internal memo to FDIC supervisory personnel outlining new procedures to be followed if and when examiners direct banks to cut off customer relationships. The directive to the bank must be in writing and receive prior approval from appropriate management personnel at the FDIC. Examiners must also have a sound legal basis other than "reputational risk" for demanding that banks end services to customers.

These actions are good news for thousands of legal lending businesses and the customers who rely on them.

Unfortunately, not everyone is on the same page with the FDIC. Bloomberg reports that Early Warning, a fraud prevention company owned jointly by several large banks, is cutting off some lenders’ access to valuable account data. Until now, the data had been available for both banks and nonbanks to use in their underwriting and fraud detection practices.

We don’t have all the facts yet, but Early Warning is reportedly telling its customers that it is cutting off lenders that charge high interest rates. The change "reflects both the wishes of our data contributors as well as various regulators," a company spokesman told Bloomberg. Early Warning’s primary metric for denying the service under its new guidelines is a rule that limits its lending customers to those that offer products with an APR at or below 36%.

These new guidelines make even less sense than now-discredited and abandoned ones used under Operation Choke Point. I have made inquiries to federal banking regulators and have not been able to find one who admits any knowledge of, or sympathy for, the new Early Warning guidelines.

Early Warning’s decision could have big repercussions. Regulators want lenders to do more to determine the ability of subprime customers to repay their loans. Cutting lenders off from Early Warning’s data undermines subprime lenders’ power to properly underwrite loans.

We can all agree that abuses in short-term lending need to be curtailed. The rub here is that access to Early Warning has made short-term lending more responsible, not less.

When lenders can verify that the identity of the customer matches his or her bank account, they are able to quickly weed out first-party fraud — that is, loan applications by individuals or groups that have no intent to repay. That means lenders are able to improve fraud scoring, which in turn leads to lower default rates and ultimately means better pricing for borrowers. Having access to this valuable data is especially important for the more innovative players in the space, which are using advanced analytics and modeling to determine pricing.

In addition, Early Warning can give lenders the opportunity to stop automated clearing house withdrawals for borrowers whose accounts do not have enough funds. That is an important protective measure for customers who face expensive insufficient funds fees, bounced check fees or overdraft charges if the lender makes a payment attempt on the account.

If Early Warning provides so many benefits to consumers, why take it away? This is not the way a competitive market should operate, and the people it hurts the most are those Americans in need of credit who face increasingly limited options.

The Consumer Financial Protection Bureau recognizes the need for short-term credit options and acknowledges it can be done responsibly. It’s time for all government agencies and private-sector businesses to operate with transparency, to acknowledge that changes in law must come from the legislative branch of government, and to recognize that a fairly regulated and competitive marketplace is necessary to give consumers more and better options.

The FDIC is trying to get the industry on the right track by dismantling the remnants of Operation Choke Point. Now it is time for the rest of the industry — regulators and businesses alike — to follow suit.

William M. Isaac, a former chairman of the Federal Deposit Insurance Corp., is senior managing director and global head of financial institutions at FTI Consulting, which represents many clients throughout the world, some of which have interests in the issues considered in this article. The views expressed are his own.