Direct-deposit advances from banks are cheaper for borrowers than taking out payday loans or racking up overdraft fees. What's vexing to regulators, consumer advocates and banks themselves is whether they're cheap enough — or fairer.
The small-dollar, short-term loans are on the brink of expanding beyond a handful of large banks thanks to several recent developments. To facilitate such advances, the National Credit Union Administration last month relaxed its usury caps. Fiserv Inc., one of the banking industry's largest technology providers, is marketing them as a substitute for payday loans and bank overdraft programs. And the Office of the Comptroller of the Currency says it is mulling guidelines.
With credit card lending and other forms of unsecured personal credit still slow, advance loans could offset some retail revenue hits threatened by regulatory reform and offer a potential source of demand growth.
"If you give customers a fair product and a fair price, you can keep them with you," said Fiserv's Jeff Burton, who promotes the company's deposit-advance package as providing operating margins akin to those of overdraft fees after taking into account fewer chargeoffs.
Despite its selling points, the product still faces resistance. After misadventures in subprime debt, many bank executives are loath to provide new types of credit to a population that by definition has cash-flow problems — especially with consumer groups looking over their shoulders.
"You're effectively making loans to someone who doesn't have other credit options and doesn't have any money," said Aaron Fine, a consultant for Oliver Wyman who predicts such products will multiply. "It's hard to make that loan at terms that don't raise eyebrows."
Deposit-advance loans aren't entirely new. Under names such as "relationship advance," major companies such as Wells Fargo & Co., U.S. Bancorp and Fifth Third Bancorp offer credit to customers with repayment premised on future account inflows. The general model is to keep the term of the loan ultrashort — a little over a month, maximum — and charge about $10 for every $100 borrowed.
Figures on the profitability of such loans, and the behavior of borrowers who use them, are scarce. But Fiserv, which helped design some of the initial programs (it won't say which ones) said the product has been a success.
Deposit-advance loans are said to be significantly cheaper and more transparent than overdraft programs. Customers must consciously decide to take out credit, and the standard price easily beats the $35 fee that many big banks charge for overdrafts. Part of the reason that overdrafts cost as much as they do is that a sizable fraction of the credit extended won't be recovered — unpaid overdrafts are the leading reason that banks close down accounts. According to Fiserv, all but a "pretty low percent" of deposit-advance customers pay within the given period.
One advantage banks have in making such loans is their access to customer data. Unlike a payday lender or even a standalone credit card company, a bank can observe other changes in a client's account — say a rapid balance decline or progressively larger payments to a payday lending company — and decide that further credit isn't a wise idea.
"The impact of customers who choose to leave the banking space can be profound" on both lender and borrower, Burton said. "In combination with payday loans, services like overdraft that banks offer can really put the customer in a bad position."
Deposit advances therefore offer potential common ground for banks and consumer lending critics. However, few significant commercial banks have marketed products that meet activists' requirements for safe short-term loans.
"Opening up line-of-credit products for people who are facing shortfalls can be a positive thing," said Leslie Parrish, a senior researcher for the Center for Responsible Lending. "My main concern is the repayment structure."
Under the standard terms for a deposit-advance loan — a 10% fee and a repayment from the next deposit — borrowers have little time to rebuild their finances before the bill comes due, potentially forcing them to take out subsequent advances.
"That structure is not that much of an improvement," Parrish said. "If the term was stretched out long enough, where people could reasonably set aside a chunk of their paycheck, that would differentiate them from payday," she said.
At least one sizable bank has been thinking about how to do just that. At a June financial services innovation conference sponsored by SourceMedia, which publishes American Banker, Michael Griffin, KeyCorp's senior vice president of community development banking, spoke about the company's ongoing effort to produce a loan that would fulfill its requirement for social responsibility.
The effort began several years ago, when the bank's product development group presented Griffin's group with what was at the time a fairly standard deposit-advance product. It was certain to be profitable but, in Griffin's mind, indefensible.
"We're going to get slammed upside the head," he said at the conference, recalling his reaction to the initial internal proposal.
To Griffin, the most objectionable element was the near-immediate repayment. Extending the term of the loan, while certain to mean higher losses, was essential.
"I am very clear that the bank is not a nonprofit," he said at the conference. "But any product that lends to somebody desperate enough to borrow $500 today, in two weeks to expect that person to have funds to repay you, along with the funds they need to live on, this is me speaking personally here, but I believe that is just disingenuous."
Regulators and community groups advocated for a 90-day repayment, Griffin said, but it appeared that that length would expose Key to excessive losses.
"Sixty days is about as far we could get to," Griffin said, given the prospective product's 6% fee and 18% APR.
The bank layered other customer safety features, too, including a prohibition on drawing a customer's account below $100. "That doesn't sound like a lot, but we really didn't want to take anyone's last dime to repay this," Griffin said.
If such forbearance prevented repayment within 60 days, "we're not going to hit them with a fee," Griffin said. "They're just going to pay the additional interest."
The version of the proposed loan Griffin presented would be profitable for the bank to make, he said — though less so than charging 10% and requiring as-soon-as-available repayment.
The loan's features are potentially ones that some consumer groups could support. Though the Center for Responsible Lending does not endorse specific terms, "we are in favor of products that allow consumers to repay over time," Parrish wrote in an e-mail to American Banker. "This seems more in line with the pricing and structure of an overdraft line of credit, which we encourage consumers to enroll in if they want overdrafts covered."
KeyCorp declined to discuss the status of the product, saying only that it was working on a "similar" product that should not be categorized as a "relationship advance" loan. A comment from Griffin's June presentation might explain that hesitation. "I was warned long ago not to call this a payday lending alternative lending product," he said. "Somehow even saying the words payday lending somehow tainted the bank, was the image people had."
Ensuring that deposit advances don't all get lumped together as marginal lending products is one of Fiserv's challenges in the current market.
Though Burton says that all deposit-advance programs are preferable to overdraft and payday, "We are really trying to challenge that 35-day window and see if it may be better to actually extend that," he said, referring to the typical maximum duration of bank deposit advances. "I would anticipate that you'll see lots of creative options in the next 18 months that will address these needs."
One possible kick-start to the market would be regulators' take on how banks should design deposit-advance programs. Regulators haven't made any such suggestions yet, but a spokesman for the OCC said it has formed a working group that may issue industry guidance.