WASHINGTON — Facing strict new guidelines on deposit-advance loans, banks must now decide if it's worth their while to offer short-term credit to cash-strapped borrowers.
Industry observers are skeptical about the future of the loans, which are often likened to payday loans, following the release of new rules from federal banking regulators Thursday. Guidelines proposed by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. would place such tight restrictions on the loans that observers say they will likely no longer make economic sense to offer.
"This is their way of killing the product," says Jeremy Rosenblum, a bank industry lawyer at Ballard Spahr.
Meanwhile, the Federal Reserve Board, which has drawn flak from consumer advocates for refusing to join the other two banking agencies, released its own views on deposit advances. The Fed also raised concerns about the short-term, small-dollar loans, saying that banks should consider the potential risks involved, including potential consumer harm and compliance risk. But its advisory did not include the detailed new standards put out by the OCC and the FDIC.
Reaction to the Fed's advisory was mixed. Some consumer advocates greeted it with cheerful surprise, saying that its language is more aggressive than they had anticipated. But industry lawyers expressed the view that the Fed's document won't have a major impact.
Only six banks are believed to offer deposit advances today. Four of them — Wells Fargo (WFC), U.S. Bank (USB), BOK Financial (BOKF) and Guaranty Bank (GBNK) — are regulated by the comptroller's office. The other two — Regions Financial (RF) and Fifth Third Bank (FITB) — are state-chartered banks that are regulated by the Fed.
The inter-agency split raises the possibility that banks supervised by the OCC will be chased out of the deposit-advance business, while those regulated by the Fed will be able to continue, at least in the short term.
The Consumer Financial Protection Bureau is eventually expected to issue rules covering both payday lenders and banks that offer deposit advances. That could make the split between the OCC and the Fed a moot issue, but it will likely take some time.
On Thursday, banking officials and consumer advocates pored through the documents from the OCC, the FDIC and the Fed in an effort to assess their likely impact.
The OCC and FDIC proposals, which will be opened for public comment next week, are virtually identical. They would require banks to review a borrower's ability to repay a deposit advance loan based on their other financial obligations.
The proposals state that repeatedly offering deposit advances for extended periods of time to the same borrower, a process known as churning, is a sign of inadequate underwriting.
The OCC and FDIC would also prevent banks from offering more than one payday loan at a time and no more than one loan per monthly statement cycle. Some banks already use such cooling-off periods, but the two agencies raised questions about their effectiveness, suggesting that today's cooling-off periods have loopholes.
"We have significant concerns regarding the misuse of deposit advance products," Comptroller of the Currency Thomas Curry said in a press release.
The two agencies also said that a bank must evaluate the customer's income, as well as inflows and outflows of their deposit account for at least six months, before underwriting a short-term credit. And it must reevaluate the borrower every six months. Delinquent or adverse borrowers would not be eligible for an advance.
The OCC and FDIC proposals would also bring scrutiny to third-party vendors that assist banks in offering deposit advances, particularly if the vendor gets a portion of the fees.
"The existence of third-party arrangements may, when not properly managed, significantly increase institutions' legal, operational and reputational risks," the OCC stated.
Taken together, the proposed restrictions raise serious questions about the continuing ability of OCC-regulated banks to offer deposit advances.
"My immediate reaction is that it's going to be very difficult to offer these products," says Lynne Barr, a banking lawyer at Goodwin Procter. "And in particular, the thing that strikes me the most is that the underwriting standards for these loans will be very difficult to comply with."
The OCC's proposed guidance has far more requirements on the underwriting of deposit advances than its previous guidance, issued in June 2011, did. Because of the costs associated with those detailed new underwriting standards, banks may begin to question the sustainability of the product, says Nessa Feddis, vice president and senior counsel at the American Bankers Association.
"It adds to the cost which goes to the sustainability of the product," Feddis says. "Either costs go up or the product gets eliminated."
Rosenblum, of Ballard Spahr, lamented the fact that the OCC and FDIC did not deal with the question of where consumers will turn for short-term, small-dollar credit if banks no longer provide it. (Bankers suggest that payday lenders will be the beneficiaries of a crackdown, though regulators are also encouraging banks to offer consumer more sustainable short-term loan products.)
But Rosenblum also noted that a footnote in the OCC document states that the proposed guidance does not apply to overdraft lines of credit, which are credit lines that get accessed when a customer overdraws his account.
"So you could do a product that shared some characteristics with these deposit advance products if you structured it formally as an overdraft line of credit," Rosenblum says.
Consumer advocates rejoiced Thursday over the OCC and FDIC proposals.
"Requiring banks to assess a borrower's ability to repay and make loans that borrowers can afford to repay is just common sense," read a statement from more than a dozen individuals who lead financial reform advocacy organizations, civil rights groups and consumer groups.
"Payday loans have been decimating the bank accounts of some of America's most vulnerable residents and we applaud the work of federal regulators to rein in these practices," read a statement from George Goehl, executive director of National People's Action.
The Fed's three-page statement does not say that banks need to underwrite deposit advances based on the borrower's ability to repay them — a key part of why industry officials see the OCC and FDIC actions as onerous.
Bank industry lawyers said they did not see a lot to worry about in the Fed's statement. But lawyers at the Center for Responsible Lending, which had been expecting very little by way of a crackdown from the Fed, were pleasantly surprised by some of the language in the Fed document.
"We wish they would have come out as explicitly as the FDIC and the OCC," says Kathleen Day, a spokeswoman for the organization, explaining that the organization wanted the Fed to match the other agencies' proposals for strict underwriting rules and cooling-off periods. "But this is pretty good. This basically, in a more roundabout way, says much the same thing."
The banks that offer deposit advances were largely silent about the looming regulatory changes.
Wells Fargo, Regions and U.S. Bank all said they were reviewing the proposed guidance and declined further comment. Fifth Third also declined to comment. A spokesperson for BOK Financial said the company was anticipating the new regulations and was in the process of reviewing them. Guaranty Bank did not return a call seeking comment.