The use of payday loans, check-into-cash pitches and car-title loans that are so ubiquitous here and in many other states have long been a target of consumer advocates. They rightly object to states' allowance of rapacious high-cost, short-term loans that often put borrowers into inescapable long-term debt traps. But it's not just the walk-in quick-loan shops that gouge consumers. Some of the nation's biggest banks offer an equivalent lending debt trap -- "advance-deposit" loans.
Here's how it works. Instead of making small loans at reasonable rates, they offer to make a short-term advance deposit in your checking account if you have direct pay deposits being made to your account. In return, they get first dibs for repayment on the advance, plus a fee, from your next direct deposit, whether it's your next paycheck, Social Security benefit or another form of deposit. The fee might be, say, $50 on a $500 bridge loan that you might only need for a few days. If that quick payback leaves you in the same hole, you can keep taking repeat advance-deposits online from your bank.
A National Public Radio reporter, John Ydstie, recapped the experience of Annette Smith, a 69-year-old California woman who got snared in that debt trap. She started with an advance deposit of $500 from her Wells Fargo branch bank in December 2007 to tide her over until her $1,200 Social Security check arrived. But she could never get out of the hole, and wound up borrowing the same quickie bridge loan amount again and again -- 62 times. Her total fees: $2,952.50.
Federal regulators under the Treasury Department and the Federal Reserve are supposed to get new consumer protection powers under the Dodd-Frank banking reform to address such lending abuses, but Republicans still are obstructing implementation of new regulations. Regardless, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. have proposed new rules on "deposit-related consumer credit products" that would curb abuses of advance deposit lending for "small-dollar, short term" loans for customers whose deposit account "reflects recurring direct deposits." The rule would apply to the nation's six largest banks, and set further industry guidelines.
The sensible "guidance" statement from the OCC says the new rule will apply specifically to high-fee, direct-advance deposits that are repaid in a lump sum ahead of the customer's other bills. It points out that effective interest on such loans can rise to 300 percent, and that banks and other financial institutions "often do not utilize fundamental and prudent banking practices to determine the customer's ability to repay the loan and meet other necessary financial obligations."
Under the new rule, banks would have to establish a 30-day wait between loans to reduce chances of a debt spiral. In addition, they would have to wait until existing loans had been paid off. Other aspects of the rule would address marketing and require clear descriptions of interest rates and cumulative fees. Banks also would have to assess a customer's ability to pay to eliminate predatory lending.
All of these rules are well founded, yet banks are objecting to them. Part of the reason for that, of course, is that banks, in search of profits since the recession, have found predatory lending to be a significant source of new revenue. Practices such as advance deposits and underwriting overdrafts are typically accompanied by huge fees that their customers can't avoid, especially if banks can quickly recapture their money ahead of other bills from a customer's next deposit.
The new federal rules should generate more prudent lending and customer borrowing. Longer-term debt and lower-interest loans would serve most credit-worthy customers better. They also would help people avoid an alternative rush to small payday lending operations, which merit strict oversight, as well.