The difference between an innovative new credit product and a prettied-up payday loan may be in the eye of the beholder. But when that eye belongs to a regulator, the consequences can be devastating for a company.
The recent demise of TandemMoney LLC, a South Dakota-based start-up that was partnering with two banks, appears to have been the result of unwelcome scrutiny from federal banking regulators.
TandemMoney's downfall underscores the pitfalls facing companies that try to develop new consumer finance products – particularly in the underbanked market – and the tensions between innovation and regulation, between expanding access to financial services and protecting consumers.
Before TandemMoney closed its doors, it developed a prepaid debit card that allowed customers to borrow short-term money, but only if they set aside $20 in savings every month. Some advocates for the unbanked saw the savings requirement as an intriguing innovation, while other consumer advocates denounced the product, calling it a payday loan in disguise.
In July, the Office of the Comptroller of the Currency took action against one of TandemMoney's partners, Urban Trust Bank of Lake Mary, Fla., ordering it to prepare an analysis of the risks associated with its prepaid debit program.
Subsequently, investors pulled out of TandemMoney because of concerns about regulatory scrutiny, according to the BankTalk blog, which broke the news of the company's shutdown.
In an email to American Banker, Trent Sorbe, company's former president, blamed the company's demise on regulators, though he did not provide specifics.
"The closure of TandemMoney is another unfortunate example of a regulatory environment that discourages innovation, scares away private capital, and ensures that banks will never threaten the grip nonbank lenders have on the provision of small dollar consumer credit," he wrote.
Sorbe would not say how many customers the company had, or answer any other questions. Urban Trust Bank did not return a call seeking comment.
TandemMoney's fall came fast. In September 2011, the company was featured at Finovate, a national conference that features young, technology-oriented firms in the financial sector. Sorbe pitched the company's product as a way to wean borrowers off high-cost loans, which the poor often use to meet their short-term needs.
"It's important to understand: with Tandem, you have to be a saver to be a borrower," he said at the conference. "It's a way for customers to manage what they have, save for tomorrow, and borrow for emergencies."
Sorbe gave the hypothetical example of a cardholder who initially needs to rely entirely on a loan to cover an unexpected $80 expense. Four months later, the consumer, who is putting aside $30 per month in savings, has enough of a nest egg to cover more than half the cost of a surprise $200 bill. At that point the borrower starts saving $70 per month. So three months later, the customer has enough savings to pay the entire cost of another $200 expense.
TandemMoney used the marketing slogan "Financial Freedom Starts Here." And it won accolades from some advocates for the unbanked, because its approach acknowledged that low-income borrowers often find themselves trapped in a cycle of debt that prevents them from building their own rainy-day funds.
Adam Rust, the author of the BankTalk blog, which focuses on the finances of the unbanked, wrote several posts about the TandemMoney, describing what he saw as both its advantages and disadvantages. He saw the savings requirement as a positive innovation.
"Savings is a really big problem among the low-income, low-wealth community," Rust said in an interview.
Speaking about TandemMoney, he added, "They had an idea that perhaps will be revisited again."
A potentially more problematic aspect of TandemMoney's offering involved its relationship with the banking system.
The company's prepaid card was offered by Urban Trust Bank, and direct deposits were supposed to flow into that account, while the savings account and line of credit were provided by Premier Bank of Rock Valley, Iowa.
Splitting the customer relationship between two banks allowed TandemMoney to work around federal restrictions regarding the garnishment of debt repayments from bank accounts where customers receive government benefits. The set-up may have raised alarm bells with banking regulators.
The National Consumer Law Center, a nonprofit advocacy organization, voiced a more fundamental objection to TandemMoney's business. It argued that prepaid cards should not be allowed to have credit features at all.
"We believe that prepaid cards ought to be prepaid. They ought to be a safe place for people to have a transaction account," said Lauren Saunders, an attorney with the organization.
Saunders expressed worry that prepaid cards are being used to evade laws in states that ban or restrict payday lending.
"I think regulators are very concerned about prepaid with credit features," she said. "Any of the states that have significant regulation of payday loans should fear prepaid cards that come in and try to circumvent them."
The National Consumer Law Center also took issue with TandemMoney's pricing structure. For example, it noted that customers who did not keep borrowing or saving would get hit, after four months, with a $5 per month inactivity fee.
Although TandemMoney's savings requirement had some attractive aspects, Saunders said, it didn't appear to mitigate the customer's cycle of debt, and in some cases exacerbated the borrower's situation.
"The word innovation gets thrown around a lot to insulate bad practices, and we need to encourage the right kind of innovation, and not the wrong kind," she said.
Sorbe, meanwhile, took strong issue with his company's critics.
"Our objective was to bring competition to a marketplace plagued by an abundance of damaging financial products," he said in an email. "This endeavor can best be summarized by our mission statement: ‘Leave the Customer in a Better Place.'"
Sorbe contrasted TandemMoney's lending product with payday loans. He said that payday loans are structured to trap borrowers, while TandemMoney used underwriting standards designed to evaluate the borrower's ability to repay, and its saving feature was meant to supplant the need to do short-term borrowing.
He also complained that banking regulators are not giving innovative companies enough patience and flexibility as they seek to create new business models to compete against high-cost nonbank lenders.
"Unfortunately, there exists no desire on the part of the federal bank regulators to allow for reasonable flexibility and innovation during the infancy of a product," he wrote.