Financial institutions that offer deposit advance products recently received supervisory guidance from the Federal Deposit Insurance Corporation with a warning about the “credit, reputational, operational and compliance risks” associated with the products.
Deposit advance products are akin to traditional payday loans as “a type of small-dollar, short-term credit product” for customers that have a deposit account or reloadable prepaid card, the FDIC explained, where the customer takes out a loan that is repaid from the proceeds of the next direct deposit.
“The final supervisory guidance released today aims to alert financial institutions to the risks posed by certain deposit advance products and to encourage institutions to meet the demand for small-dollar loans through affordable products that are prudently underwritten and designed,” FDIC Chairman Martin J. Gruenberg said in a statement. The “Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products” is intended to supplement the agency’s existing guidance on payday loans and subprime lending.
The FDIC said the design of deposit advance products coupled with weak underwriting can raise issues under the Truth in Lending Act, the Equal Credit Opportunity Act, as well as potential UDAAP violations.
Pursuant to the guidance, banks must assess a customer’s ability to repay the loan by analyzing recurring deposits and outflows over a six-month period to ensure that the individual can “continue to meet typical recurring and other necessary expenses such as food, housing, transportation and healthcare, as well as other outstanding debt obligations.”
In addition to financial capacity, the underwriting process should also consider the length of the customer’s relationship with the bank and undertake ongoing customer eligibility review no less than every six months, to check for risks such as repeated overdrafts.
The guidance also outlines a “cooling off” period of at least one monthly statement cycle after an advance loan has been repaid before another advance can be extended.
“[A]ppropriate supervisory action to address any unsafe or unsound banking practices associated with these products, to prevent harm to consumers, and to ensure compliance with all applicable laws,” will be taken by the FDIC, the agency said.
Examinations will include an assessment of credit quality, underwriting and credit administration policies and practices, as well as an evaluation of compliance with applicable federal statutes and management oversight. Banks with repetitive deposit advance borrowings could be criticized in the Report of Examination, which could be factored into a bank’s ratings, the guidance noted.
To read the FDIC guidance, click here.
Why it matters: The FDIC reported that it received more than 100 comments on the proposed guidance, with many commenters expressing concern that the agency is overreaching by promulgating new regulations in the area of consumer protection. In response, the FDIC said the guidance is intended to “highlight supervisory expectations based on applicable laws and regulations.” Further, the guidance – and specifically the determination of a consumer’s financial capacity – will not prove overly burdensome for banks. Recognizing the need for small-dollar credit products, the agency said that if structured properly, the products “can provide a safe and affordable means for customers to transition from reliance on high-cost debt products.” The FDIC also urged banks “to develop new or innovative programs” to meet the need for small-dollar credit, however, “that do not exhibit the risks associated with deposit advance products and payday loans.”