State and federal regulators appear to be orchestrating a series of actions to force financial institutions and third-party payment processors to stop doing business with certain online consumer installment lenders.
The Department of Justice has reportedly issued subpoenas to banks and processors. The Federal Deposit Insurance Corp., seemingly in conjunction with the DOJ, is descending upon financial institutions that do business with processors. Such efforts go beyond the FDIC's traditional skepticism and antipathy for processors. Also, Benjamin Lawsky, New York's superintendent of financial services, has sent letters to many of the biggest banks in the country, advising them that they should not accept automated clearing house transactions from a number of online lenders. These developments are likely to have significant implications for community banks, as well as for innovation, consumer choice and the efficiency of the retail payment networks.
At the crux of this attack on banks and processors is an effort to choke off access to the payment network for certain online lenders and merchants with "high" return rates, or percentages of ACH debits that the consumer's bank returns unpaid or for a refund. An anonymous DOJ official told The Wall Street Journal that the merchants need to be "chok[ed] off from the very air they need to survive" and Lawsky has used similar language in reference to the lenders.
The DOJ and the FDIC, in particular, are seeking to use threats and coercion to convince community banks and processors to cease doing business with these online lenders. In the case of the DOJ, there is the prospect of expensive litigation. Such costs cause a financial institution to enter into a settlement agreement to stop the bleeding. The DOJ would then use such a document as a warning to any financial institution that seeks to provide such services.
For instance, the DOJ has alleged that an overall return rate of 3% on all of a merchant's ACH transactions should be the benchmark for what is considered fraud, since it is higher than the industry average tracked by the trade group Nacha. But this is misleading. This rate does not distinguish among the type of the return (unauthorized entries are very different from returns due to insufficient funds), the nature of the transaction or the customer base (poor people tend to bounce more items). Under Nacha rules, a paper check that has bounced may be converted to an electronic form and re-presented using the RCK standard entry class code. According to Nacha, in 2012, 60.48% of RCK transactions were returned, and of those, 83.7% were returned for non-sufficient funds. Yet, no one is claiming these transactions are fraudulent. The DOJ also compares the card networks' rates of disputed transactions to the overall ACH return rates. But these are two completely disparate numbers. Card network disputed rates do not include transactions that are declined when the card is swiped. ACH returns, on the other hand, can include cases of insufficient funds or incorrect account information, along with debits disputed by the accountholder.
The FDIC has been descending on banks threatening enforcement action to the extent they can find any weakness in compliance management systems. Examinations are lasting weeks during which management teams are burdened with extensive document requests.
The question is whether the government should be able to use its full enforcement arsenal to force institutions to stop doing business with parties who provide a legal product, albeit one that those agencies apparently find distasteful. We who work in relatively well-paid professions like law and banking can all agree we are pleased that we have viable credit alternatives, and therefore, do not need to resort to small-dollar loans with high rates of interest and high fees. Our preference for, and ability to access, cheaper credit should not lead us to conclude others do not want this product.
Interestingly enough, the people who actually borrow on such terms advised the Consumer Financial Protection Bureau that they overwhelmingly like having access to such credit and understand the costs of the loans they are receiving. Nonetheless, the CFPB, in its study of "payday" lending, stated its belief that such credit could create a "debt trap."
The CFPB was authorized by Congress, in the Dodd-Frank Act, to adopt regulation governing payday lenders. To date, it has not done so. So, here we have an instance where two agencies have taken it upon themselves to use the might of government to eliminate a product that they do not believe consumers should be able to access (despite the desires of those consumers themselves) without going through the rulemaking process that is the exclusive province of the CFPB in the case of such products.
One way to consider this issue is that it is a fight between the online lenders, on one hand, and the DOJ and the FDIC, on the other hand. Unfortunately, the FDIC and the DOJ are painting with an extremely broad brush as to whom they consider bad actors when they include the banks and processors. The precedential effect is alarming. After online installment consumer lending, what comes next? New York Attorney General Eric Schneiderman is investigating whether payroll cards shortchange employees. Should payroll cards be outlawed by the threat of enforcement action without appropriate rulemaking?
Also, what do regulatory efforts to interfere with the payment system do to innovation? Do we really want to be empowering regulators using enforcement powers to be deciding what technological innovations are in the best interests of the American people?
A processor is generally a software company that processes a variety of payment instruments, such as ACH transfers. They are so prevalent in the banking system that we do not even consider them as third parties. They include firms such as PayChex, Fiserv, Jack Henry and FIS. There are even software companies that process payments for registering for a marathon, for filing tax returns with tax preparers, and for the vast majority of online businesses that are too small to do this work themselves. In fact, the vast majority of payroll in this country and the tax payments for payroll are performed by third party payment processors.
In short, what is occurring is not the appropriate use of enforcement sanctions against malfeasance. Instead, it is a systematic effort to root out a product under the guise of claims of inappropriate conduct. Bankers should insist that efforts like these go through the rulemaking process of the CFPB. The CFPB is required by law to weigh such issues as availability of credit in deciding whether to adopt a rule. This is a much better approach than the use of unchecked police powers.
Peter G. Weinstock leads the financial institutions corporate and regulatory practice at Hunton & Williams LLP.