When financial regulators do something right, it should be noted.
Two weeks ago, the Federal Deposit Insurance Corporation and the Office of Comptroller of the Currency did something very right: They issued a joint guidance document that bans abusive payday lending by the thousands of banks they oversee. Unfortunately, the Federal Reserve did not do the same, so the banks it regulates can continue to make these loans.
In April, when the FDIC and OCC first came out with their proposal, financial industry lobbyists raised a storm of protest. The result, they warned, would be to drive people back into the arms of storefront loansharks.
Indeed, payday lending was a storefront industry until a little over a decade ago, when a handful of banks began offering so-called "deposit advances." As multiple studies have shown, however – and as the two regulators affirmed last week – these offerings bear all the trademarks of the worst payday loans, including high fees, lump-sum repayment within a few weeks, direct lender access to borrowers' deposit accounts (and income streams), and the tendency for one loan to become a cascade of loans at the equivalent of triple-digit interest.
The banks are charging that interest, moreover, to their own account-holders, and specifically to those with direct deposit and a record of steady earnings – hardly a high-risk customer base.
Consider the Senate testimony of Annette Smith, a 69-year-old California woman who ended up paying $3,000 for what was essentially a single $500 loan from Wells Fargo. Smith had gone into the bank looking for a few hundred dollars to repair her truck. After explaining that Wells didn't make loans on that small scale, a bank officer encouraged her to apply for a Direct Deposit Advance online. (Wells, like the other banks offering such products, avoided using words like "loan" or "interest" in its marketing.)
Smith testified that she had "never considered going to one of those payday loan stores because I knew they had a reputation for charging really high interest rates that I could never afford." Mistakenly assuming that a major bank wouldn't do that kind of thing, she "went home and with just a few clicks, received $500 into my account." And "a couple of weeks later when my Social Security check was deposited electronically to my account," she continued, "the bank withdrew the $500 plus a $50 fee. Back then my monthly Social Security check was for less than $1,200. That means that the $550 that I paid Wells Fargo that month was about half of what I had to live on for the month. Without it, I could not afford to pay my rent and all my other bills and expenses. So, a few days later, I took out another $500." Thus her $500 loan morphed into a five-year cycle of debt.
About half of all bank payday loan customers are, like Smith, retirees living on Social Security; and according to a study published by the Consumer Financial Protection Bureau in April, banks often seize monthly benefits before their customers can pay for food, prescriptions or other basic expenses.
The banks claim to be serving a particular set of customers – those with "an immediate expense that needs to be deferred for a short period of time and … sufficient influx of cash by the next pay period to retire the debt," as the CFPB study puts it. And yet, the study adds, "it does not appear that lenders attempt to determine whether a borrower meets this profile before extending a loan."
Under the new guidelines, banks will have to verify an applicant's ability to repay without repeated borrowing, and no customer will be able to receive more than one loan in a two-month period. That boils down to "no more deposit advances," since the business model depends on heavy repeat business. The typical borrower takes out 14 loans a year, the CFPB says.
Payday loans, regardless of where they are made, are designed to take advantage of people in desperate circumstances. Thanks to a long campaign of grass-roots activism, 14 states and the District of Columbia have passed laws limiting or prohibiting such loans. But with the Internet making it increasingly easy for lenders to operate across state lines, the struggle will have to be won in Washington too.
The Consumer Financial Protection Bureau, which has authority over bank and nonbank lending practices, will be a key player. In addition to its valuable research on the problem, the CFPB recently announced its first payday-loan enforcement action. The Dallas-based Cash America agreed to pay more than $19 million in refunds and fines for robo-signing debt-collection documents, violating a 36 percent interest rate cap for members of the military and destroying evidence. (According to the CFPB, a Cash America subsidiary had deleted recorded calls with consumers, instructed employees to conceal materials from regulators and shredded documents, even after being ordered to stop.) The next step for the CFPB is a rule dealing with abusive payday practices.
With the FDIC/OCC directive, the banking world is now split between one large group of institutions which cannot make payday loans, and another large group of institutions which can – because their regulator, the Fed, continues to permit the practice. Two of those banks, Fifth Third and Regions, are currently in the payday-lending business.
Last week an alliance of community groups delivered petitions in which more than 12,000 people (including many supporters of National People's Action and Americans for Financial Reform) called on Regions Bank to drop its "Ready Advance" loans, which come with a $2 cash advance fee for each $10 borrowed. The groups also staged protests outside Regions Bank offices in Decatur, Ill. Columbia, Mo., and Urbandale, Iowa, where the rally featured a spokesperson in a shark suit.
Regions, like Fifth Third, could decide to do the decent – and reputation-protecting – thing by discontinuing these products without being ordered to do so. As long as the Federal Reserve continues to offer a safe haven, however, there's not much likelihood of that. And other banks may be tempted to get into the game. Who knows where the shark suit will show up next.
Jim Lardner is the communications director at Americans for Financial Reform, a coalition of more than 250 civil rights, consumer, labor, business, investor and other groups working for a strong, stable and ethical financial system.