Recently, the Federal Deposit Insurance Corporation (“FDIC”) and the Office of the Comptroller of the Currency (“OCC”) issued final supervisory guidance (FDIC guidance, OCC guidance) for financial institutions that offer so-called “deposit advance products.” By using these products, borrowers generally receive small-dollar, short-term loans and promise to repay them from the proceeds of their next paycheck (or benefit disbursement), which are direct-deposited into the borrower’s bank account. Notably, the regulators’ guidance applies to deposit advance products “regardless of how the extension of credit is structured” (e.g., as a loan or a line of credit).
A close review of these guidelines reveals three principles that banks should consider when offering deposit advance products:
• Assess the Borrower’s Ability to Repay
o Pre-Existing Banking Relationship (6 months) with the Borrower: A bank should “ensure that the customer relationship is of sufficient duration” such that the bank may “prudently underwrite deposit advance loans.” The guidance establishes a bright-line rule regarding the required duration, noting that the regulators “will consider sufficient duration . . . to be no less than six months.”
o Initial Assessment of Borrower Eligibility: Prior to issuing a loan, a bank should analyze the borrower’s ability to repay the loan without resorting to repeated borrowing from any source. Financial institutions should assess not only the borrower’s current account balance, but also deposits and withdrawals over at least six consecutive months. However, banks need not use credit reports to make these assessments.
o Ongoing Assessment of Borrower Eligibility: At least every six months, banks should reevaluate the borrower’s eligibility for deposit advance loans and identify risks, such as repeat overdrafts, that could negatively affect the borrower’s eligibility.
• Place Limits on Repeat Usage
o One Loan at a Time: The guidance states that a deposit advance loan should be repaid in full before a subsequent one is made.
o Maximum of One Loan Every Two Months: Banks should not offer more than one deposit advance loan per monthly statement cycle, and a “cooling-off period” of at least one monthly statement after repayment should be observed before another loan is made. These requirements suggest an effective annual limit of six deposit advance loans per borrower.
o Restriction on Increasing Credit Limits: A borrower’s deposit advance credit limit should not be increased without a full underwriting assessment, and any increase should not be automatic but should be initiated only at a borrower’s request.
• Closely Scrutinize Related Practices and Procedures
o Over-Reliance on Fee Income: The FDIC and OCC will take note of the amount of a financial institution’s revenue that is earned through fee income from deposit advance loans.
o Enhanced Compliance: Financial institutions offering deposit advance loans should implement an effective compliance management system that ensures adherence to the consumer financial laws (e.g., ECOA, TILA, EFTA). Further, a bank should maintain higher capital ratios for deposit advance loan portfolios given their increased default rate, and should closely scrutinize its allowances for loan losses.
o Management Oversight: “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.”
o Third-Party Relationships: The FDIC and OCC will monitor a financial institution’s relationship with its vendors that administer its deposit advance products, and banks may be held responsible for the violations of its vendors.
Although the principles in the guidance above will likely operate to limit the number of deposit advance loans extended, the guidance itself does not constitute an outright ban. Instead, the FDIC and OCC noted that “[a] number of banks are currently offering reasonably priced small-dollar loans at reasonable terms to their customers,” and that the regulators “encourage banks to respond to customers’ small-dollar credit needs . . . . in a safe and sound manner.” Lastly, the Federal Reserve Board (“FRB”) did not join in this final guidance, although the FRB previously released a policy statement that largely echoed the guidance, outlining potential risks associated with deposit advance products and warning member banks to provide such credit responsibly.