As Advance Cash Lending Faces New Regulations, Big Banks Want In
Advance cash loans, which are sometimes called paycheck advances, have become increasingly popular since the 1990s. Most borrowers can obtain small-dollar loans with just a verifiable source of income and a checking account, and many lenders do not run credit checks or require a minimum credit score. The loans are typically due in full on the borrower’s next payday. In recent years, cash advances and similar loans have faced mounting criticism, leading some states to enact regulations that ban these types of loans or restrict them in various ways. Although the federal government has historically left the issue to the states, the pending regulations proposed by the Consumer Financial Protection Bureau offer sweeping changes that could affect every financial institution offering small-dollar, short-term loans regardless of where the institution or the borrower are based. Despite — or because of — the proposed regulations, big banks are expressing a desire to be allowed to offer these types of loans. What many people do not realize is that numerous banks once offered a similar product that was essentially regulated out of existence.
Advance Cash Loans: Why the Big Banks Want Back In
Most banks actively cultivate an image that conveys their desire to help customers achieve their dreams, make banking more convenient and be a friendly financial partner. However, banks are intended to be profit-making businesses, so if they are interested in making advance cash loans, it is because they see the potential to generate revenue through these loans.
Finding new revenue streams may be necessary for many banks; the CFPB and various consumer groups have recently started criticizing the fees charged by banks for returned checks and overdraft protection. According to Money.com, overdraft fees for the year that ended in June 2015 accounted for more than $32 billion in revenue for American banks. The CFPB has taken note of this revenue stream and expressed serious concerns; the median fee was $34, but the majority of the fees were on debit card purchases of $24 or less. Furthermore, over 50 percent of the accounts became positive in no more than three days; 75 percent required no more than a week to show a positive balance. As the CFPB notes, the annual percentage rate for borrowing $24 for three days is approximately 17,000 percent. No payday lender charges annualized percentage rates that are even remotely close.
The CFPB has not yet proposed new regulations for overdraft fees, but an article appearing in the Financial Times states that the agency may do so soon. Federal regulators have already attempted to rein in overdraft fees; in 2010, a new rule was enacted requiring financial institutions to secure the account holder’s consent before charging a fee for permitting a debit card or ATM transaction that would overdraft the account. However, since the regulation does not apply to automated payments or checks, it is up to the bank’s discretion whether to reject the transaction or allow an overdraft. Should the bank opt to allow an overdraft resulting from an automated payment or check, the bank can charge the overdraft fee even if the consumer did not consent to debit card coverage.
Overview of the Advance Cash Loans Once Offered by Banks
Typically, banks referred to these loans as deposit advance products. Most lenders capped the loans at $1,000 and required that the customer’s account reflect a history of regular direct deposits. The loans and associated fees were repaid in a lump sum from the customer’s next direct deposit.
In 2013, the Federal Deposit Insurance Corporation issued guidelines for all banks offering deposit advances. The justification used by the FDIC was remarkably similar to the criticism leveled at payday lenders.
• The loans often involved high fees that had triple-digit annual percentage rates. For example, suppose a bank charged $50 for a cash advance of $500. The loan was repaid one week later. The annual rate of interest would exceed 500 percent.
• Banks did not apply adequate underwriting criteria to ensure that the borrower could repay the loan while meeting other expenses.
• Cash advances were short-term loans that could be difficult for borrowers to repay. Because repayment would occur when the bank received the next direct deposit, the loan term could be as little as one day; repayment was typically required in no more than 35 days.
• Requiring repayment in a lump sum could leave borrowers without the funds to meet their other expenses. Borrowers might turn into repeat users and become mired in a cycle of debt.
The guidelines issued by the FDIC required banks to conduct an assessment of the borrower’s ability to repay the loan without impacting his or her ability to meet other obligations. The FDIC instructed banks to ascertain the borrower’s housing, food, health care, transportation and other debts before establishing a loan amount.
This underwriting had to occur prior to the loan and be monitored periodically. Since the FDIC considered repetitive loans as a possible indication of weak underwriting, repetitive cash advances could be criticized in the examiner’s report and potentially affect the bank’s ratings. Banks were instructed to limit cash advances to no more than one per monthly statement cycle; a new loan could not be made until a minimum of one statement cycle had elapsed since the previous loan was repaid.
When underwriting advance cash loans, banks had to analyze the customer’s deposits and withdrawals over a period of six or more consecutive months. The net balance in the customer’s account on the last day of each month had to be considered when deciding whether the customer could afford his or her normal expenditures as well as the loan payment. Underwriting had to be conducted at least every six months, and the banks were to monitor the accounts for signs that the customer might be overextended or otherwise ineligible for additional loans.
Furthermore, the FDIC warned that advance loans could raise issues under the Federal Trade Commission Act that prohibits unfair or deceptive practices. The prohibition applies to every activity related to the product, including marketing materials. The FDIC also notified banks that they must comply with the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act and the Equal Credit Opportunity Act as well as all applicable FDIC rules. As a result of the new regulations, most banks stopped offering deposit advance loans in early 2014.
How Banks Feel About Proposed CFPB Regulations
Banks that are hoping to grab a piece of the market for payday loans naturally want to see the guidelines issued by the FDIC in 2013 scrapped. After all, these regulations forced them to stop offering these types of short-term, small-dollar loans in the first place. However, they also want to see the new rules proposed by the CFPB blocked, stating that the new regulations — which address deposit advance loans specifically as a product that is classified in a category that is separate from payday loans — would prevent them from making these loans. The Consumer Bankers Association and the American Bankers Association have suggested scrapping the CFPB and FDIC regulations and offered additional suggestions for encouraging banks to enter the small-loan market.
However, it is not just the big banks who object to the CFPB’s proposed rules. In June 2016, the Credit Union National Association and the Independent Community Bankers of America sent a joint letter to the CFPB voicing opposition to the new regulations. Community banks are typically small, locally owned financial institutions that are not affiliated with a larger bank or a financial holding company. Normally, community banks receive deposits from and loan money to local businesses and individuals. As the ICBA pointed out in a letter to the CFPB regarding the proposed regulations, community banks tend to develop close relationships with customers that allow bankers to become familiar with the financial circumstances, ability to repay and borrowing history of their customers. The insights gleaned through personal relationships, according to the ICBA, let community banks make decisions that are not necessarily based on cut-and-dried underwriting rules. The ICBA fears that the proposed regulations will force community banks from the small-dollar, short-term loan marketplace to the detriment of consumers.
Even the large banks believe that they need relief from the CFPB’s proposed regulations to make cash advances profitable. Under the new rules, the underwriting costs would be more or less the same for a $500 loan as they would for a $20,000 loan. However, the bank would stand to earn significantly more from the interest paid on the larger loan, offsetting the underwriting costs and still allowing the bank to earn a profit.
The Credit Union National Association notes that the small-dollar loans made by credit unions cannot be neatly categorized. CUNA states that the scope is overly broad, sweeping in auto refinance loans and other unrelated products. Furthermore, CUNA feels that the complexity of the new regulations — especially the underwriting requirements — could prevent many credit unions from offering cash advance loans.
Although credit unions and banks find the underwriting requirements too burdensome as proposed, there are other issues that could hamper the re-entry of banks into the advance cash marketplace. The CFPB is proposing that cash advances have loan amounts of $500 or less and offer loan terms of no more than 45 days. Before approving a loan, lenders will be required to verify that borrowers do not have any covered loans outstanding with any lender. Cooling-off periods, total months of indebtedness and the number of sequential loans are also included in the proposed regulations.
The CFPB specifies some slightly different rules for longer-term loans. If the loan term is greater than 45 days but less than 180 days, the interest rate is no more than 28 percent, the application fee does not exceed $20 and the borrower does not have other covered loans, lenders could make two loans to a borrower during a six-month period. A second approach allows lenders to make two loans per year if the borrower’s monthly payment does not exceed 5 percent of his or her gross monthly income.
The decision by the CFPB to include a specified interest rate is troubling for two reasons. First, the CFPB does not have the authority to regulate interest rates, but by linking an interest cap to a rule, the agency is essentially doing just that. Second, one need only look at what has happened in states that have chosen to cap payday loans at 36 percent per annum. For example, after New Hampshire and Montana capped annualized interest rates on deferred deposit loans at 36 percent, payday lenders with physical stores closed their businesses in droves. When the Military Lending Act imposed a maximum interest rate of 36 percent for active duty members or their dependents, most lenders simply stopped making cash advance loans to members of the military.
Simply stated, an annual percentage rate of 36 percent has not proven to be sufficient for lenders to offer advance cash loans — even without the burdens imposed by the pending regulations. According to an article posted on AL.com, payday lenders spend as much as 66 percent of their total revenue just to staff their stores and cover operating expenses. Credit unions and banks are more diversified, so their costs can be allocated over a wide range of other services. However, if banks are required to conduct the same underwriting process for a $500 cash advance loan as for a $100,000 loan, the smaller loan would be so costly that the bank would need to charge rates almost as high as payday lenders or lose money on every small-dollar loan.
If the CFPB, the FDIC and other regulators continue to impose restrictions, banks will not be able to carve out a piece of the small-dollar loan marketplace. At the same time, regulators are allowing banks to assess overdraft fees that exceed the cost of an advance cash loan and have a higher annual percentage rate as well. This incongruity has led some to wonder whether regulatory agencies truly care about the millions of American consumers who need access to small-dollar loans — the very loans that are at risk of being regulated out of existence.
Examine the Issues in Greater Detail
Consumer credit decisions can be difficult, especially for customers with credit difficulties or those who have yet to establish a credit history. Knowledge can be empowering, so if you would like to learn more about the CFPB proposed regulations, advance cash loans or other matters related to personal finance, visit the Personal Money Store to find helpful articles on topics that matter to you.