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Been There; Done That: Banks Should Stay Out of Payday Lending

July 12, 2017
Payday Loans
Research

Banks once drained $500 million from customers annually by trapping them in harmful payday loans. In 2013, six banks were making triple-digit interest payday loans, structured just like loans made by storefront payday lenders. The bank repaid itself the loan in full directly from the borrower’s next incoming direct deposit, typically wages or Social Security, along with annual interest averaging 225% to 300%. Like other payday loans, these loans were debt traps, marketed as a quick fix to a financial shortfall. In total, at their peak, these loans—even with only six banks making them—drained roughly half a billion dollars from bank customers annually.  These loans caused broad concern, as the payday loan debt trap has been shown to cause severe harm to consumers, including delinquency and default, overdraft and non-sufficient funds fees, increased difficulty paying mortgages, rent, and other bills, loss of checking accounts, and bankruptcy.

Recognizing the harm to consumers, regulators took action protecting bank customers. In 2013, the Office of the Comptroller of the Currency (OCC), the prudential regulator for several of the banks making payday loans, and the Federal Deposit Insurance Corporation (FDIC) took action. Citing concerns about repeat loans and the cumulative cost to consumers, and the safety and soundness risks the product poses to banks, the agencies issued guidance advising that, before making one of these loans, banks determine a customer’s ability to repay it based on the customer’s income and expenses over a six-month period. The Federal Reserve Board, the prudential regulator for two of the banks making payday loans, issued a supervisory statement emphasizing the “significant consumer risks” bank payday lending poses. These regulatory actions essentially stopped banks from engaging in payday lending.

Industry trade group now pushing for removal of protections. Today, in the current environment of federal deregulation, banks are trying to get back into the same balloon-payment payday loans, despite the extensive documentation of its harms to customers and reputational risks to banks. The American Bankers Association (ABA) submitted a white paper to the U.S. Treasury Department in April of this year calling for repeal of both the OCC/FDIC guidance and the Consumer Financial Protection Bureau (CFPB)’s proposed rule on short- and long-term payday loans, car title loans, and high-cost installment loans.

Allowing high-cost bank installment payday loans would also open the door to predatory products. At the same time, a proposal has emerged calling for federal banking regulators to establish special rules for banks and credit unions that would endorse unaffordable installment payments on payday loans. Some of the largest individual banks supporting this proposal are among the handful of banks that were making payday loans in 2013.  The proposal would permit high-cost loans, without any underwriting for affordability, for loans with payments taking up to 5% of the consumer’s total (pretax) income (i.e., a payment-to-income (PTI) limit of 5%).  With payday installment loans, the loan is repaid over multiple installments instead of in one lump sum, but the lender is still first in line for repayment and thus lacks incentive to ensure the loans are affordable. Unaffordable installment loans, given their longer terms and, often, larger principal amounts, can be as harmful, or more so, than balloon payment payday loans.  Critically, and contrary to how it has been promoted, this proposal would not require that the installments be affordable.

Recommendations: Been There, Done That – Keep Banks Out of Payday Lending Business

  • The OCC/FDIC guidance, which is saving bank customers billions of dollars and protecting them from a debt trap, should remain in effect, and the Federal Reserve should issue the same guidance;
  • Federal banking regulators should reject a call to permit installment loans without a meaningful ability-to-repay analysis, and thus should reject a 5% payment-to-income standard;
  • The Consumer Financial Protection Bureau (CFPB) should finalize a rule requiring a residual income-based ability-to-repay requirement for both short and longer-term payday and car title loans, incorporating the additional necessary consumer protections we and other groups called for in our comment letter; 
  • States without interest rate limits of 36% or less, applicable to both short- and longer-term loans, should establish them; and
  • Congress should pass a federal interest rate limit of 36% APR or less, applicable to all Americans, as it did for military servicemembers in 2006.