Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products Notice Posted in Federal Register
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Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products
A Notice by the
Publication Date:
Agency:
Entry Type: Notice
Action: Final guidance.
Document Citation: 78 FR 70552
Page: 70552 -70558 (7 pages)
Document Number: 2013-28306
Shorter URL: https://federalregister.gov/a/2013-28306
Action
Final Guidance.
Summary
The
FOR FURTHER INFORMATION CONTACT:
SUPPLEMENTARY INFORMATION:
I. Introduction
The
II. Description of Guidance
A deposit advance product is a small-dollar, short-term loan or line of credit that a bank makes available to a customer whose deposit account reflects recurring direct deposits. The customer obtains a loan, which is to be repaid from the proceeds of the next direct deposit. These loans typically have high fees, are repaid in a lump sum in advance of the customer's other bills, and often are not subject to fundamental and prudent banking practices through which a bank can determine the customer's ability to repay the loan and meet other necessary financial obligations.
The
III. Comment Letters Received
The
Several commenters stated they believed the
Many commenters also questioned whether guidance relating to a determination of a customer's financial capacity and the level of effort necessary to complete such an analysis may be overly burdensome. The
Several commenters also expressed concerns that this Guidance would have a "chilling effect" on the overall small-dollar, short-term credit market, and potentially drive consumers to illegal and/or unregulated lenders. However, the
Certain other commenters expressed concerns with the underwriting requirements as they relate to classified credits. Specifically, commenters interpreted the proposal to mean it was necessary to look outside of their bank (e.g., obtaining a credit report) to determine whether the customer had any delinquent or adversely classified credits, and was therefore ineligible for their product. This was never the intent of the Guidance. The
A number of other commenters questioned whether the Guidance would be applicable to deposit advance products that are designed to resemble "lines of credit" given that the proposal uses the term "loan." To address this concern, language has been added to state that the Guidance is applicable to all deposit advance products regardless of how the extension of credit is structured.
Some commenters, primarily state regulatory agencies, raised the concern that the Guidance would preempt applicable state laws, including usury laws, and potentially limit the ability of states to regulate these types of products. This was never the intent of the Guidance. Therefore, to address these concerns, the
Commenters also raised concerns about banks using the proceeds of certain government benefits (e.g.,
A related concern raised by commenters had to do with the impact of the "cooling off" period. For example, the commenters felt a required cooling off period might result in some customers obtaining larger advances than they might otherwise, because their access to additional advances would be delayed by the cooling off period.
The Guidance makes clear that an
IV. Guidance
The text of the Guidance follows:
FDIC Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products
The
Background: A deposit advance product is a type of small-dollar, short-term credit product offered to customers maintaining a deposit account, reloadable prepaid card, or similar deposit-related vehicle at a bank. The bank provides a credit feature that allows the customer to obtain a loan in advance of the customer's next direct deposit. The deposit advance is based on the customer's history of recurring deposits. Typically, the advance is offered as an open-end line of credit. [4] While the specific details of deposit advance products vary from bank to bank, and also may vary over time, those currently offered incorporate some or all of the characteristics described below.
Cost: The cost of the deposit advance is typically based on a fee structure, rather than an interest rate. Generally advances are made in fixed dollar increments and a flat fee is assessed for each advance. For example, a customer may obtain advances in increments of
Eligibility, Loan Limits, and Ability to Repay: Typically, a customer is eligible for a deposit advance if the deposit account has been open for a certain period of time and the customer receives recurring deposits. Banks typically require a minimum sum to be directly deposited each month for a certain period of time in order for the customer to be eligible for a deposit advance loan. Currently, some banks permit a recurring deposit as low as
The maximum dollar amount of the advance is typically limited to a percent or amount of the recurring monthly deposit. For example, some banks permit the deposit advance to be the lesser of
Typically, the bank does not analyze the customer's ability to repay the loan based on recurring debits or other indications of a need for residual income to pay other bills. The decision to advance credit to customers, based solely on the amount and frequency of their deposits, stands in contrast to banks' traditional underwriting standards for other products, which typically include an assessment of the ability to repay the loan based on an analysis of the customer's finances.
Repayment: Repayment is generally required through an electronic payment of the fee and the advance with the next direct deposit. Typically, the bank is paid first before any other transactions are paid. In some cases, a bank will apply a time limit on how soon it will take the fee and the advance from the direct deposit, but the time limit is minimal, usually one or two days. If the first deposit is insufficient to repay the fee and the advance, the repayment will be obtained from subsequent deposits. If the deposits are insufficient to repay the fee and the advance within a certain time period, typically 35 days, then the bank executes a forced repayment by sweeping the underlying deposit account for the remaining balance. Unlike a payday lender, the bank has automatic access to the underlying deposit account. In some cases, customers may be able to access program features that allow for a longer repayment period than 35 days; however, this is not usually allowed.
If the deposit account funds are insufficient to repay the fee and the advance, then the account goes into overdraft status. Some banks will charge an overdraft fee based on the deposit advance overdrawing the account. Other banks will only charge overdraft fees based on any subsequent transactions that overdraw the account.
Although the deposit advance limit is based on an amount or percentage of the monthly deposit, the repayment can be based on a shorter time period. For example, if a customer receives direct deposits of
Some banks have implemented alternative repayment methods that provide more flexibility to the customer. For example, some banks will permit repayment to extend through to the second direct deposit if the first direct deposit falls below a specific dollar threshold. In addition, some banks allow payment by mail rather than electronic transfer, but may charge a fee for this option. Finally, some banks offer an installment loan option, but may also charge an additional fee or may only offer this option if the customer cannot repay the advance and fee from the monthly deposits.
Repeat Usage Controls: Banks often have repeat usage limits that trigger a "cooling off" period during which the customer cannot take out a deposit advance, or the credit limit is reduced. For example, some banks may prevent an advance for 35 days if the customer has used the service at least once each month in the previous six-month period. However, the customer can resume use of the product after the 35-day period is completed. Other banks may prevent an advance for one full billing cycle if the customer borrows the entire amount of the advance each month in the previous six months. However, the customer can avoid this limit by taking out something less than the maximum advance.
Marketing and Access: Banks market deposit advance products as intended to assist customers through a financial emergency or to meet short-term needs. These advances, however, are typically not included with the bank's list of available credit products, but are instead listed as a deposit account "feature." Customers are alerted to the availability of the products by a reference on their account statements or a "button" or hot link on their personal accounts' Web pages, but it is not clear that the customers are made equally aware of less expensive alternatives.
Supervisory Concerns With Deposit Advance Loans
Although the
The combined impact of both an expensive credit product and short repayment periods increases the risk that customers may end up using what is marketed as a short-term credit product that results in debt over an extended period of time. Specifically, deposit advance customers may repeatedly take out loans because they are unable to fully repay the balance in one pay period while also meeting typical recurring and other necessary expenses (e.g., housing, food, and transportation). Customers may feel compelled to take out another loan very soon thereafter to make up for the shortfall. This is similar to the practice of "loan flipping," which the OCC, the
To address concerns that certain customers become dependent on deposit advance products to meet their daily expenses (as evidenced by their repeated borrowings), certain lenders now require customers who have taken out a specified number of deposit advance loans within a certain time frame to wait for a specified period before they are eligible to take out a new loan. However, the
Weak underwriting increases the risk that the customer's account may become overdrawn and result in multiple overdraft fees when subsequent transactions are presented for payment. Some banks assess overdraft fees when the automatic repayment of the deposit advance loan causes the associated account to reflect a negative balance.
Safety and Soundness Risks
Credit Risk: Customers who obtain deposit advance loans may have cash flow difficulties or blemished or insufficient credit histories that limit other borrowing options. The high aggregate cost of numerous and repeated extensions of credit that may be a consequence of this product further increases credit risk. Lenders that offer deposit advance loans typically focus on the amount of the customer's monthly deposit for underwriting purposes. Failure to consider whether the income sources are adequate to repay the debt while covering typical living expenses and other debt payments presents safety and soundness risks.
Numerous and repeated extensions of credit to the same individual may be substantially similar to continuous advances and subject the bank to increased credit risk. While re-aging, extensions, deferrals, renewals, and rewrites of lending products can be used to help customers overcome temporary financial difficulties, such practices, if repeated, can cloud the true performance and delinquency status of the portfolio. [6]
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. This failure to properly assess the customer's financial capacity, a basic underwriting principle, increases default risk.
Reputation Risk: Reputation risk is the risk arising from negative public opinion. Deposit advance products are receiving significant levels of negative news coverage and public scrutiny. This increased scrutiny includes reports of high fees and customers taking out multiple advances to cover prior advances and everyday expenses. Engaging in practices that are perceived to be unfair or detrimental to the customer can cause a bank to lose community support and business.
Third-Party Risk: Banks remain responsible for compliance with all applicable laws and regulations, including the activities of a third party. [7] The
Legal Risk: The significant risks associated with deposit advance lending products may subject banks to the risk of litigation -- both from private lawsuits and regulatory enforcement actions.
Compliance and Consumer Protection Related Concerns
Deposit advance products must comply with all applicable federal laws and regulations, some of which are outlined below. In some circumstances, certain state laws may be applicable. [8] It is important that a bank's deposit advance products be reviewed by counsel for compliance with all applicable laws prior to implementation. Furthermore, although the guidance below outlines federal laws and regulations as of the date this Guidance is published, applicable laws and regulations are subject to amendment. In addition, statutes and regulations will have different applications depending on how a deposit advance product is structured. A bank offering deposit advances should carefully consider whether and how these laws and rules will apply to the particular version of the deposit advance product it is providing. Accordingly, a bank should monitor applicable laws and regulations for revisions and to ensure that its deposit advance product is fully compliant. Federal laws and regulations applicable to deposit advance products include the following:
The Federal Trade Commission Act (FTC Act): Section 5 of the FTC Act prohibits unfair or deceptive acts or practices (UDAP). [9] The
Deposit advance products may raise issues under the FTC Act depending upon how the products are marketed and administered. Any FTC Act analysis will be dependent on the facts and circumstances in a particular matter.
The prohibition on UDAP applies not only to the product, but to every stage and activity, from product development to the creation and rollout of marketing campaigns, and to servicing and collections. For example, marketing materials and disclosures should be clear, conspicuous, accurate, and timely and should describe fairly and adequately the terms, benefits, potential risks, and material limitations of the product.
Truth in Lending Act (TILA): TILA and Regulation Z require creditors to provide cost disclosures for extensions of consumer credit. [11] Different rules apply to Regulation Z disclosures depending on whether the loan is an open- or closed-end credit product. A bank should ensure the product's disclosures comply with the applicable requirements. TILA advertising rules for open-end credit require that, if an advertisement states any periodic rate that may be applied, it must state the rate as an Annual Percentage Rate, using that term. [12] Similarly, TILA advertising rules for closed-end credit require that, if an advertisement states a rate of finance charge, it must state the rate as an Annual Percentage Rate, using that term. [13]
Electronic Fund Transfer Act (EFTA): A program that involves the use of electronic fund transfers must meet the applicable disclosure and other requirements of EFTA and Regulation E. [14] EFTA requires disclosures, [15] prohibits creditors from mandating that loans be repaid by "preauthorized electronic fund transfers," [16] and allows customers to withdraw authorization for "preauthorized fund transfers." [17]
Truth in Savings Act (TISA): A program that involves a consumer's deposit account must meet the disclosure requirements of
Equal Credit Opportunity Act (ECOA): Under ECOA and Regulation B, creditors are prohibited from discriminating against an applicant on a prohibited basis in any aspect of a credit transaction. [21] This prohibition applies to deposit advance products. The creditor's discretion, for example in determining the application of eligibility requirements, loss mitigation options, and fee waivers, may raise fair lending risk. [22] Steering or targeting certain customers on a prohibited basis toward deposit advance products while offering other customers more favorable credit products may also raise fair lending risk. Additionally, providing different product terms or conditions and different servicing or loss mitigation options to similarly situated customers on a prohibited basis may also violate ECOA.
In addition to the general prohibition against discrimination, ECOA and Regulation B contain specific rules concerning procedures and notices for credit denials and other adverse actions. Regulation B defines the term "adverse action," and generally requires a creditor who takes an adverse action to send a notice to the consumer providing, among other things, the reasons for the adverse action. [23]
Supervisory Expectations
Deposit advance lending presents significant consumer protection and safety and soundness concerns, irrespective of whether the products are issued by a bank directly or by a third party. The
Examiners will assess credit quality, including underwriting and credit administration policies and practices. In addition, examiners will assess the adequacy of capital, reliance on fee income, and adequacy of the allowance for loan and lease losses (ALLL). Compliance with applicable federal consumer protection statutes, management's oversight, and relationships with third parties will also be assessed.
Credit Quality: The Uniform Retail Credit Classification and Account Management Policy (Retail Classification Policy) establishes guidelines for classifying consumer loans, such as deposit advance loans, based on delinquency, but also grants examiners the discretion to classify individual retail loans that exhibit signs of credit weakness, regardless of delinquency status. An examiner also may classify consumer portfolios, or segments thereof, in which underwriting standards are weak and present unreasonable credit risk.
Deposit advance loans often have weaknesses that may jeopardize the liquidation of the debt. Customers often have limited repayment capacity. A bank should adequately review repayment capacity to assess whether a customer will be able to repay the loan without needing to incur further deposit advance borrowing.
Deposit advance loans that have been accessed repeatedly or for extended periods of time could be evidence of inability to repay and inadequate underwriting. A bank should monitor for repeated or extended use, as will be discussed in greater detail in the discussion of underwriting expectations below.
Underwriting and Credit Administration Policies and Practices: As part of the credit quality review, examiners will assess underwriting and administration policies and practices for deposit advance loan products. Eligibility and underwriting criteria for deposit advance loans, consistent with eligibility and underwriting criteria for other bank loans, should be well documented in the bank's policy. The criteria should be designed to assure that the extension of credit, including all associated fees and expenses, can be repaid according to its terms while allowing the customer to continue to meet typical recurring and other necessary expenses such as food, housing, transportation, and healthcare, as well as other outstanding debt obligations. Additionally, criteria should ensure that customers can meet these requirements without needing to borrow repeatedly. Banks should maintain appropriate criteria to prevent churning and prolonged use of these products. Underwriting for deposit advance products should occur prior to opening such accounts and should be monitored on an ongoing basis. Repetitive deposit advance borrowings could indicate weak underwriting and may be criticized in the Report of Examination and then taken into account in a bank's ratings, as appropriate.
Bank policies regarding the underwriting of deposit advance loan products should be written and approved by the bank's board of directors, and be consistent with the bank's general underwriting standards and risk appetite. Factors a bank should address in its written underwriting policies for deposit advance products include the following:
* The Length of a Customer's Deposit Relationship With the Bank. A bank should ensure that the customer relationship is of sufficient duration to provide the bank with adequate information regarding the customer's recurring deposits and expenses in order to prudently underwrite deposit advance loans. The
* Classified Credits. Customers with delinquent or adversely classified credits with the bank that is offering the deposit advance product should be ineligible.
* Financial Capacity. In addition to any eligibility requirements, the bank should conduct an analysis of the customer's financial capacity, including income levels. [24] Underwriting assessments should consider the customer's ability to repay a loan without needing to borrow repeatedly from any source, including re-borrowing, to meet necessary expenses. The financial capacity assessment should include:
? An analysis of the customer's account for recurring deposits (inflows) and checks/credit/customer withdrawals (outflows) over at least six consecutive months. Lines of credit of any sort, including overdrafts, and drafts from savings, should not be considered inflows. In reviewing a customer's transactions to determine deposit advance eligibility, the bank should consider the customer's net surplus or deficit at the end of each of the preceding six months, and not rely on a six-month transaction average.
? After conducting the above-described analysis, determine whether an installment repayment is more appropriate.
* Cooling Off Period. Each deposit advance loan, along with all applicable fees, should be repaid in full before the extension of a subsequent deposit advance loan, and a bank should not offer more than one loan per monthly statement cycle. [25] A cooling off period of at least one monthly statement cycle after the repayment of a deposit advance loan should be completed before another advance may be extended in order to avoid repeated use of the short-term product.
* Increasing Deposit Advance Credit Limits. The amount of credit available to a customer should not be increased without a full underwriting reassessment in compliance with the bank's underwriting policies and in accordance with the factors discussed in this Guidance. Additionally, any increase in the credit limit should not be automatic and should be initiated by a request from the customer.
* Ongoing Customer Eligibility. As part of underwriting for this product, a bank should, no less than every six months, reevaluate the customer's eligibility and capacity for this product. Additionally, a bank should identify risks that could negatively affect a customer's eligibility to receive additional deposit advances.
For example:
? Repeated overdrafts (establish/set a certain number during a specified number of months).
? Evidence that the customer is overextended with respect to total credit obligations.
Additionally, a bank should monitor for repeated customer usage, which may indicate a need for alternative credit arrangements or other services, and inform customers of these available options when appropriate.
Capital Adequacy: Higher capital requirements generally apply to loan portfolios that exhibit higher-risk characteristics and are subject to less stringent loan underwriting requirements. Loans exhibiting subprime credit characteristics are higher- risk loans and may require higher levels of capital.
Over-Reliance on Fee Income: Fees associated with deposit advance products should be based on safe and sound banking principles. A bank should monitor for any undue reliance on the fees generated by such products for its revenue and earnings.
Adequacy of the Allowance for Loan and Lease Losses (ALLL): Examiners will assess whether the ALLL is adequate to absorb estimated credit losses within the deposit advance loan portfolio. Examiners will also determine whether a bank engaged in deposit advance lending has methodologies and analyses in place that demonstrate and document that the level of the ALLL is appropriate.
Consumer Compliance: A bank should implement effective compliance management systems, processes and procedures to mitigate risks appropriately. Examiners will review a bank's program with respect to deposit advance products for compliance with applicable consumer protection statutes and regulations, including TILA, EFTA,
Operational Risk and Third-Party Relationships: A bank is responsible for ensuring that the processes and systems and the associated internal controls are appropriate for the delivery of products to the customer in a safe and sound manner, and in compliance with laws and regulations, whether performed by the bank or a third party. In the review of a bank's relationships with third parties, the
Management Oversight: Examiners will assess bank management's ability to administer a deposit advance program and board oversight of the program. Furthermore, examiners will determine whether bank management has established controls and implemented a rigorous analytical process to identify, measure, monitor, and manage the risks associated with deposit advance products.
A bank should maintain adequate oversight of deposit advance programs and adequate quality control over those products and services to minimize exposure to potential significant financial loss, reputation damage, and supervisory action. The bank's compliance management system should ensure continuing compliance with applicable federal and state laws, rules and regulations, as well as internal policies and procedures.
Management should provide the appropriate oversight and allocate sufficient qualified staff to monitor deposit advance programs. Results of oversight activities--including identified weaknesses that should be documented and promptly addressed--should be reported periodically to the bank's board of directors or designated committee.
Responsible Products To Meet Small-Dollar Credit Needs
The
Dated at
Executive Secretary.
Footnotes
1. See"Proposed Guidance on Deposit Advance Products," 78 FR 25268 (
2. FDIC Financial Institutions Letter FIL-14-2005, "Guidelines for Payday Lending," (Guidelines for Payday Lending) (
3. This Guidance does not apply to banks' overdraft lines of credit. Overdraft lines of credit typically do not have repayment characteristics similar to deposit advance products. Back to Context
4. This Guidance applies to all deposit advance products, regardless of whether the deposit advance product is structured as open- or closed-end credit. Back to Context
5. Subprime Lending Guidance, jointly signed by the OCC, the Board, the
6. See"
7. See FDIC FIL 44-2008, "Guidance for Managing Third-Party Risk" (
8. The Guidance has no bearing on state usury laws or existing federal laws regarding usury. See 12 U.S.C. 85, 1831d(a). Back to Context
9. 15 U.S.C. 45(a) and (n). Back to Context
10. Joint Board and FDIC Guidance on "Unfair or Deceptive Acts or Practices by State-Chartered Banks" (
11. 15 U.S.C.
12. See 12 CFR 1026.16(b)(1). Back to Context
13. See 12 CFR 1026.24(c). Back to Context
14. 15 U.S.C. 1693 et seq. EFTA is implemented by Regulation E, 12 CFR Part 1005. Back to Context
15. See, e.g., 12 CFR 1005.7, 1005.8, and 1005.9. Back to Context
16. See 12 CFR 1005.10(e). Back to Context
17. See 12 CFR 1005.10(c). Back to Context
18. 12 U.S.C. 4301 et seq.
19. See 12 CFR 1030.4(b)(4). Back to Context
20. See 12 CFR 1030.8. Back to Context
21. 15 U.S.C. 1691 et seq. ECOA is implemented by Regulation B, 12 CFR Part 1002. ECOA prohibits discrimination on the basis of race, color, religion, national origin, sex, marital status, age (provided the applicant has the capacity to contract), the fact that all or part of the applicant's income derives from a public assistance program, and the fact that the applicant has in good faith exercised any right under the Consumer Credit Protection Act. Back to Context
22. See Interagency Fair Lending Examination Procedures (
23. See 12 CFR 1002.2(c) and 1002.9. Back to Context
24. While a bank may choose to obtain and review a customer's credit report for the purposes ofassessing financial capacity or ongoing eligibility, obtaining a customer's credit report to assess ability to repay is not expected pursuant to this Guidance. Back to Context
25. The Interagency "Expanded Guidance for Subprime Lending Programs" (2001) states that loans to borrowers who do not demonstrate the capacity to repay the loan, as structured, from sources other than the collateral pledged, in this case the customer's direct deposit, are generally considered unsafe and unsound. Such lending practices should be criticized in the Report of Examination as imprudent. Back to Context
26. See FDIC Financial Institutions Letter FIL-50-2007, "Affordable Small-Dollar Loan Guidelines," (
27.
TNS 30BautistaJude-131126-4561634 30BautistaJude
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