On April 25, 2013, both the OCC and the FDIC proposed guidance (the "Proposals") on deposit advance products—small-dollar, short-term credit that banks offer in competition with payday advance products offered by nonbanks. The Proposals mark a new step in the regulation of deposit advance products and may foreshadow more extensive supervision and enforcement by the CFPB of large banks and nondeposit lenders that offer the same or competing products. The Proposals came in the wake of the publication the day before of a study on payday loans and deposit advance products by the CFPB (the "Study").
Federal regulation of small-dollar, short-term credit has largely taken the form of notice and disclosure requirements based on consumer lending statutes, primarily (but not exclusively) the Truth in Lending Act. Examinations of banks engaged in the deposit advance business focus on management's ability to ensure compliance with the various federal disclosure and consumer protection statutes. The Proposals, however, take a more expansive view of the supervision and regulation of these products. Drawing on the regulators' prudential authority, the Proposals look to the substance of the deposit advance business and would require banks to make determinations about borrower eligibility, suitability, and ability to repay and to consider the appropriateness of the economic returns on the business. Given the sweeping nature of the Proposals and the possibility that the CFPB could adopt a similar approach, any firm engaged in small-dollar, short-term lending, whether in the form of deposit advances or loans and regardless of the firm’s charter, should evaluate the Proposals with care.
The appropriate starting point is the Study. This document reviews considerable data on small-dollar, short-term products of both banks and nonbanks. The CFPB draws two basic conclusions: (i) that consumers may not fully understand the costs, benefits, and risks of these products—notably that the use of the products should (in the CFPB’s view) be limited to immediate expenses where the debt can be retired in the next pay period—and (ii) that consumers may “find themselves caught in a cycle of high-cost borrowing over an extended period of time.” The CFPB promises further study into the factors contributing to sustained use of small-dollar, short-term credit products and into online versions of the product, with attention to the effectiveness of limitations, including cooling-off periods.
The CFPB has already issued examination guidelines for salary-advance loan products, but the study portends more intensive regulation. Although not specifically determining that any product or aspect of a product is unfair, deceptive, or abusive, the Study concludes by invoking the CFPB’s regulatory authority to prevent unfair, deceptive, or abusive practices in the offering of financial products. Formal guidance may be a ways off, but the CFPB has authority to bring enforcement actions in advance of any such guidance.
The Proposals discuss in detail several underwriting policies and procedures that a bank should apply to its deposit advance program. We discuss many of these below, but, since banks do not appear to have suffered material losses in these programs, the underwriting requirements may be aimed more at consumer protection than at credit risk. These requirements go well beyond the traditional disclosure standards. In particular, the Proposals address the following:
- The review of an applicant's financial capacity would be required to include an analysis of whether the borrower can repay the loan without needing to borrow repeatedly from any source, including re-borrowing, to meet necessary expenses.
- In some cases, a bank should consider whether repayment through installments rather than through debiting a deposit account would be more appropriate.
- A bank should adopt a one-month cooling-off period after repayment of a deposit advance.
- Before increasing the credit limit for a borrower, a bank should engage in an underwriting reassessment. Additionally, a bank should review borrower eligibility every six months.
The Proposals would require a bank to underwrite the credit risk of a deposit advance to each borrower. Although many of the standards in the Proposals are familiar for long-term consumer lending, the short term and smaller principal amounts of deposit advances have historically made such underwriting unnecessary. Elements of an underwriting would include the following:
- The length of a customer’s deposit relationship with the bank would be a threshold consideration.
- Customers with delinquent or adversely classified assets would be ineligible for deposit advances.
- In assessing an applicant's financial capacity, a bank should review the customer’s account for recurring deposits and checks/credit/customer withdrawals over at least six consecutive months.
- Certain of the consumer protection factors above also address credit risk, including the requirements for an underwriting reassessment before a credit limit is increased and for a review of customer eligibility every six months.
The Proposals would impose three standards on the economics of a deposit advance program. First, a bank would be directed not to place "undue reliance" on fees generated by deposit advance products for the bank's revenue and earnings. Second, higher capital requirements may be necessary and would likely be modeled on the higher requirements for subprime mortgage loans. Third, a bank would be required to demonstrate and document that its Allowance for Loan and Lease Losses for a deposit advance program is adequate.
The Proposals incorporate the compliance requirements in earlier guidance on deposit advance products and small-dollar, short-term lending. The Proposals mention the following:
- Banks must have programs in place for compliance with the Truth in Lending Act, the Electronic Funds Transfer Act, the Truth in Savings Act, the Equal Credit Opportunity Act, and Section 5 of the Federal Trade Commission Act.
- Examiners will assess both management’s ability to administer a deposit advance program and the board's oversight of the program.
- Banks must demonstrate their ability to manage all of the risks arising out of the use of third parties in deposit advance programs, and the OCC and FDIC may conduct on-site reviews of third-party service providers.
Both agencies recognize consumers’ need for small-dollar credit products and encourage banks to provide them on a “responsible” basis—loans with "affordable, reasonable interest rates with no or low fees and payments that reduce the principal balance of the loan.” Nevertheless, the Proposals would establish far more extensive regulation of deposit advance programs than now exists, including the imposition of formal consumer protection standards.