On April 25, 2013, the Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency (OCC) issued their Proposed Guidance on Deposit Advance Products.1 The guidance comes only one day after the CFPB delivered its white paper highlighting the alleged risks of payday loans for consumers. The guidance articulates certain principles that the FDIC and OCC expect its member institutions that offer deposit advance products to adhere to. A deposit advance product is a short‐term loan that allows the consumer to receive an advance on an electronically deposited paycheck or recurring deposit. The loan is generally repaid by a lump sum payment from the proceeds of the next deposit or 35 days after the funds are advanced (if the proceeds of ensuing deposit are insufficient to repay the advance). In contrast to a payday loan, however, the consumer must maintain an account at that financial institution in order to qualify for a deposit advance loan.
The guidance chastised the underwriting practices for deposit advance products. The OCC and FDIC expressed concern that financial institutions failed to consider a consumer’s financial ability to repay the loan before extending a deposit advance loan. The agencies claimed that the high fees of the product in conjunction with the short repayment period, regularly traps consumers in a cycle of debt – by repeatedly taking out these loans in order to pay monthly expenses. According to the FDIC and OCC, repeated use of deposit advance products by a consumer is evidence of inadequate underwriting.2 The OCC and FDIC also suggested that financial institutions that promote deposit advance products suffer reputational injury, in light of the negative news coverage regarding these products and incur additional legal liability, from both civil lawsuits and regulatory enforcement action.
In short, the OCC and FDIC expect their member institutions to focus on the following:
- Credit Quality – Financial institutions must develop specific underwriting criteria for deposit advance loans that are reviewed and approved by the board of directors. Further, the underwriting policies must consider the applicant’s financial capacity to repay the loan before a deposit advance loan is authorized. In assessing ability to repay, the financial institution cannot consider whether the consumer can qualify for future loans to repay the current deposit advance. In developing underwriting criteria, the financial institutions should consider (1) the length of a customer’s relationship with the bank; (2) classified credits of the consumer; and (3) the financial capacity of the borrower3. Moreover, in assessing financial capacity, the institution cannot simply consider the account’s balance, but must conduct an analysis of the account for recurring deposits and withdrawals over at least six consecutive months. Further, financial institutions should require repayment of each deposit advance loan as well as a “cooling off period” of at least one monthly statement cycle prior to extending another deposit advance loan.
- Capital adequacy – Financial institutions should maintain higher capital ratios for deposit advance loan portfolios in lieu of the increased default rate for these products.
- Over‐reliance on fee income – The FDIC and OCC will take note if a financial institution earns a disproportionate share of their income from the fees generated by deposit advance products.
- Adequacy of allowance for loan and lease losses – FDIC and OCC examiners will assess whether reserves are sufficient to cover anticipated credit losses for the deposit advance loan portfolio. Financial institutions should have procedures in place to establish that sufficient reserves exist to cover losses.
- Consumer compliance – The FDIC and OCC warned that its examiners will review deposit advance product programs for compliance with consumer financial laws. If not already in place, the financial institutions must institute compliance management processes that focus on consumer financial laws, including, the Equal Credit Opportunity Act, Truth in Lending Act and Electronic Fund Transfer Act.
- Management oversight – The FDIC and OCC will probe whether upper management is closely monitoring its deposit advance products. It is critical that compliance management for deposit advance products includes strict oversight from the highest levels of the financial institution.
- Third‐party relationship – The FDIC and OCC will be monitoring the financial institution’s relationship with its vendors and third party providers in administering deposit advance products. The guidance makes clear that a member institution will be culpable for any violations of the guidance or consumer financial law by its third‐party vendors.
Additionally, the Federal Reserve Board has promulgated its own statement on deposit advance products which largely echoed the OCC and FDIC’s concerns. Specifically, the Federal Reserve Board emphasized the compliance risk in designing, marketing and collecting deposit advance loans. The Federal Reserve Board warned that failing to monitor these products could expose an institution to liability under Section 5 of the FTC Act and Section 1036 of the Dodd‐Frank Wall Street Reform and Consumer Protection Act for unfair, deceptive or abusive practices. Similar to the OCC and FDIC’s guidance, the Federal Reserve Board cautioned financial institutions to police its service providers and refrain from entering into fee arrangements, which reward a consumer’s repeated use of deposit advance products.
While the OCC, FDIC and Federal Reserve Board provide cursory praise for deposit advance products for addressing the short term, small‐dollar credit needs of consumers, it is clear that, on the heels of the CFPB white paper for payday loans, financial institutions and its service providers should be cognizant that deposit advance products are squarely in the crosshairs for further regulation and enforcement.