Bank deposit advances are payday loans in disguise
In a recent op-ed, Consumer Bankers Association President Richard Hunt asserts that bank payday loans were a service to customers and argues that they should be restarted. The facts, though, show that while these loans produced huge fees for banks, they were a usurious debt trap for bank customers.
Just a few years ago, banks were making 200%-plus APR payday loans, which they euphemistically called “deposit advance products.” While deposit advances were marketed as a small-dollar, quick fix to a budgetary shortfall, they typically led to an expensive debt trap. These were payday loans, dressed up in a suit and tie.
In 2013, regulators rightly took actions that led most, but not all, banks to stop issuing these dangerous balloon-payment payday loans. Importantly, this guidance issued by the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, and the supervisory statement from the Federal Reserve, allowed responsible credit offerings to continue unimpeded.
The data on this last era of bank payday loans showed that they are devastating for American consumers while posing serious risks to banks’ safety and soundness and their reputations.
These debt trap loans were based on the bank’s ability to seize the money from the customer’s account on payday, and banks did not consider whether the borrower could actually afford the loan. The bank only checked that there was enough money coming into the account to extract for itself the loan repayment and its sky-high interest. After the bank took its full loan amount and interest, borrowers were usually left without enough money left to pay for the necessities of life, such as housing, food and utilities. In order to make ends meet, borrowers were forced into a cycle of repeat loans.
Instead of helping them out, deposit advances pushed Americans further down a financial hole. Banks put deposit advance borrowers in an average of 19 of these loans a year at over 200% annual interest.
As with payday loans from nonbank companies, deposit advances put borrowers at serious risk of a financial free fall. For instance, deposit advance borrowers were “far more likely to overdraw their accounts” — resulting in costly overdraft fees — and “were seven times more likely to have their accounts charged off than their counterparts who did not take [deposit] advances.”
Borrowers of these bank payday loans were also more likely to have taken out a nonbank payday loan, an indication that deposit advance was not an alternative to nonbank payday loans, but merely an imitation, creating more unaffordable debt.
While this was a cash cow for banks in the short term, prudential regulators have long warned that features of this type of credit pose a threat to companies’ safety and soundness. Bank payday loans took a serious toll on companies’ reputations. Contrary to Hunt’s claim, members of Congress weighed in, urging regulators “to stop abusive bank payday lending.” Negative news articles, the outrage of community groups and “move your money” campaigns added to bankers’ headaches.
At the product’s peak, bank payday loans drained consumers of $500 million a year even though they were issued by “only” six banks — most banks didn’t want to get their hands on this dirty product.
Especially since the financial industry image in 2019 is still reeling from the 2008 crash, restarting bank payday would be unwise.
A call to return to these loans and the premise of Mr. Hunt’s op-ed — that bank payday loans help people facing a budgetary shortfall and are the only place they could turn to — is fundamentally flawed. Military service members and the approximately 100 million residents of states without payday loans employ a variety of strategies to address a cash flow shortfall. Surveys and studies show these Americans use a range of methods, credit and noncredit, to manage finances, including payment plans with utilities, credit cards, pawn loans, financial assistance from a local nonprofit, loans from religious institutions, building savings and income and turning to friends and family. These are not all ideal, but they are all far better options than payday loans.
For decades, no regulation has prevented banks from offering affordable loans, and indeed credit cards, including subprime cards, are widely available to those who can afford more credit. Secured credit cards encourage savings and build credit capacity — these should be expanded.
To guard against the return of unaffordable bank payday loans — whether balloon payment or any new wave of installment loans — regulators should require banks to check a borrower’s ability to repay the loan, a process that can be streamlined but that must consider both income and expenses. Such underwriting has long been a basic principle of sound lending. Pricing must also be reasonable. Banks should serve their customers and not get back in the business of predatory payday loans.