Regulators are cracking down on payday loans, and that could give banks an unprecedented edge in the business.
The Consumer Financial Protection Bureau has begun examining payday loans, and the Federal Deposit Insurance Corporation has raised concerns over deposit advances, a similar product offered by a handful of banks, including Wells Fargo (WFC), U.S. Bancorp (USB), Fifth Third Bancorp (FITB) and Regions Financial (RF).
But despite consumer advocates' longtime criticism of payday loans, observers do not expect regulators to do away with them entirely. Now that an increasing number of banks are offering deposit advances, industry members say the CFPB's probe could give banks an edge over some of the non-bank storefronts that have long dominated the payday lending market.
"I'd be surprised if they say it can never be a good product. … The CFPB wants to avoid discouraging banks from finding profitable ways to serve these consumers," says Jo Ann Barefoot, a co-chair at consultancy Treliant Risk Advisors. "There's definitely a possibility that whatever they do could give an advantage to bank services."
Explicit action by regulators could even help dispel uncertainty in the payday loan market, drawing in more conservative lenders like big banks.
"The silver lining of enforcement is that it separates out what you can do in a much cleaner and clearer way. If regulatory expectations are more clearly articulated, and there's a well-defined, and responsible way to do it, then you will see more banks deciding, 'OK, we're going to put a toe in the water,'" says Anand Raman, a partner at Skadden, Arps, Slate, Meagher & Flom.
Some banks have done more than dip in a toe recently, despite the prospect of increased regulatory scrutiny. Regions, for example, unveiled a payday advance last year, and promoted it at an industry conference this month.
"Customers have real emergencies, real needs. … People walk into those storefronts every day by choice," John Owen, the bank's head of business lines, said in an interview then. "We view this as a way to pull more people into the regulated banking industry, and I think that is perceived as a good thing. It is [perceived that way] by us."
And some industry members have been reassured by regulators' approach so far to payday loans. "The CFPB has said that they are going be a data-driven agency — and that has certainly been borne out in our experience," says Joseph Barloon, a partner at Skadden. "So you can expect them to consider the issue carefully before taking any action that could have a significant impact on the industry."
To be sure, whatever changes the CFPB mandates could have major implications for both nonbank and bank lenders, and could potentially limit the profitability of payday loans. The Dodd-Frank Act granted the agency authority to stop "unfair, deceptive, or abusive acts and practices, which means it could conceivably eliminate payday loans and their like altogether.
"These products are a UDAAP lightning rod simply because they're aimed at vulnerable and less sophisticated customers," says Barefoot.
And ironically, the greater threat to bank payday lenders may come from a longtime regulator, rather than the CFPB.
Martin Gruenberg, the FDIC's acting chairman, told consumer advocates in a May 29 letter that he is "deeply concerned about these continued reports of banks engaging in payday lending and the expansion of payday lending activities under third-party arrangements."
Gruenberg added in the letter that he has instructed FDIC staff to review bank payday lending activities.
"They [FDIC staff] are working with our regional offices to determine if any FDIC-supervised institutions are currently offering or contemplating offering these types of products. Once this review is completed, the FDIC Division of Depositor and Consumer Protection will provide recommendations to the FDIC Acting Chairman based on our assessment of the risks of these products," agency spokeswoman Michele Heller said in an email.
Industry observers are taking those threats seriously, in part because the Office of the Comptroller of the Currency and the FDIC pressured several banks to jettison partnerships with payday lenders in the mid-2000s.
"Until I had seen the letter the FDIC had written, I would have thought it was not such a big deal for the banks," says Alan Kaplinsky, a partner at Ballard Spahr.
"But reading that letter, it's obviously on their radar screen, and they're going to be looking at all kinds of short-term loan products where they think APR is too high or where consumers are using the product when maybe alternatives ought to be considered," he adds.
Some banks, including KeyCorp (KEY), have entirely revamped the core features of short-term loans in ways that some consumer advocates admire, such as by giving borrowers much more time to repay the loans.
Key initially looked at introducing its own version of a deposit advance, but then decided to scrap it in favor of a small dollar unsecured line of credit that allows debts to be repaid over five years.
"We quickly realized, that for us and our clients, the idea of immediate repayment when the next deposit came in was not good," says Cindy Balser, the consumer credit product designer behind Key's small dollar loan.
But many banks are sticking closer to the traditional model. In light of the CFPB's public statements thus far, it's not clear that a radical overhaul of their services will be required.
"We recognize the need for emergency credit. At the same time, it is important that these products actually help consumers, rather than harm them," CFPB Director Richard Cordray said at a January field hearing on payday loans held in Birmingham, Ala.
An agency spokeswoman declined to comment on its supervision of the payday lending market beyond Cordray's public statements in January.
If the CFPB looks at relative pricing rather than product structure, banks will likely come off looking better than non-bank peers. Though hardly cheap on a repeat basis, deposit advance products generally offer better terms than the payday loans offered by non-bank lenders. (Due to a provision included in the Dodd-Frank Act, the CFPB is barred from capping interest rates explicitly, but overall affordability can be among the bureau's considerations).
Payday loans are typically for several hundred dollars, and traditional payday lenders typically charge $15 to $20 per $100 borrowed, according to the CFPB. Bank deposit advances typically cost closer to $10 or less per $100 borrowed.
During his speech, Cordray cited particular concern over chronic usage of the loans, an issue that consumer advocates have long raised and that is likely to draw greater scrutiny going forward.
"That two-week loan rolls over and over and turns into a loan that the consumer has been carrying for months and months. Soon they're living off money borrowed at a rate of 400 percent," he said, adding that the CFPB plans to "dig deep" into the issue of repeated use.
Ballard Spahr's Kaplinsky says he expects that aspect of payday lending "to be an area where the CFPB may ultimately engage in some rulemaking."
Consumer advocates have argued that the necessity of repeat use is an essential part of both payday loans and banks' deposit advance products. According to one analysis cited by the Center for Responsible Lending, 75% of payday loan volume is due to the churn of borrowers taking out additional loans to pay back their original debt.
"We think the whole payday model is fundamentally defective," says Lauren Saunders, a managing attorney at the National Consumer Law Center. "It's classic predatory lending, exploiting somebody's short-term needs to gouge them. The structure is set up to encourage repeat lending."
Banks have already taken some steps to prevent consumers from becoming dependent on the loans as an ongoing source of financing, and those limits could conceivably be strengthened at regulators' request.
Wells Fargo, which has offered deposit advances since 1994, limits customers to taking out advances for six consecutive statement periods. After that point, the bank will reduce a customer's credit limit by $100 for each advance until the limit equals zero. (When the customer then declines to take out an advance during a statement period, the credit limit is restored.)
"We continue to hear this is an important service customers want to have access to," says Wells Fargo spokeswoman Richele Messick.
Other banks also tout their product's restrictions and competitive pricing relative to non-bank lenders.
For example, if Regions' Ready Advance customers hit their credit limit for the loans six months in a row, they are subject to a one-month "cooling off" period before they can start borrowing again.
The Birmingham bank will also begin lowering prices for repeat customers who regularly repay their loans, Owen said earlier this month.
By early next year, customers who consistently repay the short-term loans and "get a track record of credit, we'll lower the price point and increase the amount they can borrow," he said.
Regions also says that customers have reported being happy with the service so far.
"Initial feedback from customers indicates that satisfaction with this service is very high," according to spokeswoman Evelyn Mitchell.
Those comments were echoed by U.S. Bank, which has offered a deposit advance since 2006.
"Checking Account Advance is a safety net for our customers who have experienced an unexpected expense such as a medical emergency or an auto repair. A small percent of our customers use CAA, but those who have give the product overwhelmingly high marks and appreciate having it available to them for emergency use," says U.S. Bank spokeswoman Teri Charest.
All of the banks declined to discuss specific regulatory concerns surrounding the products, including recent statements by the CFPB and the FDIC.
Fifth Third declined to comment on its Early Access Checking program beyond what is provided on the bank's website. The Cincinnati bank started offering deposit advances in 2008.