The bank deposit advance a short-term form of consumer credit that strongly resembles a payday loan is on its last legs. Federal regulators have made that pretty clear.
Now a handful of affected banks confront a tricky decision: either devise a way to offer small-dollar loans that comply with disruptive new rules and still make business sense, or get out of the business altogether.
Four banks, including industry behemoths Wells Fargo (WFC) and U.S. Bancorp (USB), face this choice right away, and others will be watching closely to see if they are successful in developing a new formula for small-dollar consumer loans.
Hank Israel, a managing director at the consultant firm Novantas, says banks would be wise to stay in the business because there is strong consumer demand for small-dollar loans.
"Redesigning these programs probably makes sense," he says. "They're going to have to be more targeted."
Today, banks that offer deposit advances typically charge a $1.50 to $2 fee for every $20 borrowed, with the repayment often coming out of the borrower's next direct deposit check. Much like in the payday loan industry, borrowers frequently roll over their loans into new ones, a debt cycle that elicits harsh criticism from consumer advocates.
The regulatory guidance finalized last week by the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency includes several provisions that will sharply curtail the availability of deposit advances.
First, it requires banks to evaluate the borrowers' ability to repay without rolling the loan over. And every six months, banks will be required to reevaluate their customers' eligibility, looking at factors such as their total credit obligations and how frequently they overdraw their checking accounts.
On top of that, after the borrower repays the loan, banks will have to allow at least one statement cycle to elapse before offering another loan. This cooling-off period is expected to sharply cut into banks' revenue from the products; the Consumer Financial Protection Bureau found in a study earlier this year that light and moderate use of deposit advances accounted for less than 10% of the total loan volume.
"The punchline is that the revenue from deposit advance programs could decline as much as 90%," Novantas concluded in a written analysis of the regulatory guidance.
The guidance officially took effect on Tuesday substantially unchanged from the version that was proposed in April but none of the banks that offer deposit advance lines of credit have announced changes to their products yet.
The four banking companies that offer deposit advances and are subject to the new guidance Wells Fargo, U.S. Bank, BOK Financial (BOKH) and Milwaukee-based Guaranty Bank all say they are reviewing the provisions.
But in a comment letter filed with the regulators before the guidance was finalized, Wells Fargo stated that "several hundred thousand customers" use its deposit advance service and said that it would "be forced to discontinue" the product if the guidance took effect.
U.S. Bank stated in its comment letter that more than 90% of its customers would be disqualified by the guidance, but it did not say that it would drop the product.
Two other companies Regions Financial (RF) and Fifth Third Bancorp (FITB) are not subject to the guidance because they are regulated by the Federal Reserve Board, which declined to sign on to the document.
Banks that are regulated by the OCC and the FDIC and fail to get into compliance run the risk that their regulator will bring an enforcement action, says Kevin Petrasic, a lawyer at Paul Hastings. "This is definitely one of those situations where you could have enforcement by example," he says.
One way that banks could redesign their deposit advance products is by focusing more on consumers with higher incomes who have a need for short-term credit. Because these customers earn more, they are more likely to qualify under the strict new underwriting criteria. "I will say that this may be a more up-market game," says Novantas' Israel.
Other observers expect the banking industry to follow a path forged by payday lenders. In recent years, as two-week and four-week loans have fallen into greater disfavor with regulators, the payday industry has started offering installment loans with terms of three to nine months. Because of their longer terms, those loans often carry lower annual percentage rates.
"I think the bank regulators are starting to see that two-week loans should not exist," says one source in the consumer lending industry who asked not to be identified.
The decision facing Wells Fargo, U.S. Bank and the other affected banks is complicated by the fact that last week's guidance is likely not the final word from federal regulators on deposit advances.
Following the release of the CFPB's April white paper on payday loans and deposit advances, the consumer bureau is expected to eventually issue rules on short-term credit at both banks and nonbanks.