The FDIC issued proposed guidance on Thursday for supervised institutions that offer or plan to offer deposit advance products in order to ensure that banks are aware of the risks, compliance and safety associated with deposit advance loans.
“The proposed supervisory guidance released today reflects the serious risks that certain deposit advance products may pose to financial institutions and their customers,” FDIC Chairman Martin Gruenberg said. “Many financial institutions already profitably offer affordable small-dollar loans as an alternative to high-cost payday loans, and we encourage institutions to continue to seek ways to responsibly meet the need for small loans.”
Deposit advance loans are small-dollar, short-term loans offered by some depository institutions to customers with deposit accounts, reloadable prepaid cards or another deposit-related product.
The customer obtains the loan, the amount of which is then deducted from the customer’s next direct deposit. The loans, which are similar to payday loans, usually carry high fees and do not utilize banking practices used to determine whether a customer is able to repay the line of credit and meet other financial obligations.
Deposit advance loans are based on the customer’s history of recurring deposits and are often offered as an open-ended line of credit. The cost of the loan is usually based on a fee structure as opposed to an interest rate and can be more expensive than other forms of credit.
A customer is eligible for a deposit advance loan if the account has been open for a certain amount of time and if the customer receives recurring deposits. Borrowers are often required to have a minimum sum direct deposited in the accounts each month over a certain time period in order to be eligible for a loan.
The FDIC said in its guidance that while the regulator encourages institutions to develop methods to meet customers’ small-dollar credit needs, “deposit advance products pose supervisory risks.”
“The combined impact of an expensive credit product coupled with short repayment periods increases the risk that borrowers could be caught in a cycle of high-cost borrowing over an extended period of time,” the FDIC said, adding that deposit advance loans have some elements of predatory lending. “Though deposit advance products are often marketed as intended for emergency financial assistance, and as unsuitable for meeting a borrower’s recurring or long-term obligations, the FDIC believes the product’s design results in consumer behavior that is frequently inconsistent with this marketing and is detrimental to the customer.”
Some lenders require borrowers who have taken out a number of deposit advance loans within a certain time period to wait until they are eligible to take out further loans, “cooling periods” that the FDIC said are easily avoidable and “ineffective in preventing repeated usage of these high-cost, short-term loans.”
The FDIC also pointed to the lack of underwriting standards in determining whether a customer can repay a loan. Lenders usually focus on the amount of the borrower’s monthly deposit but do not consider whether income sources are adequate to repay the debt and meet financial obligations.
“Relying on the amount of the customer’s incoming deposits without consideration of expected outflows does not allow for a proper assessment of the customer’s ability to repay the loan and other necessary expenses,” the FDIC said. “This failure to properly assess the borrower’s financial capacity, a basic underwriting principle, increases default risk.”
The FDIC said underwriting policies should address factors such as the length of a customer’s deposit relationship with the bank, delinquent or adversely classified credits, the ability of a customer to meet necessary expenses, increasing loan limits, cooling off periods and ongoing customer eligibility.
Additionally, the FDIC said institutions should monitor for “any undue reliance” on fee income generated by deposit advance loans, implement effective compliance management processes and procedures, ensure adequate quality control over deposit advance products and ensure continued compliance with state and federal laws.