Lately, the number of payday loan lenders in the United States, and their critics, are growing in number. Many associate the payday lending industry with over-priced and un-regulated loans. However, that is not exactly the case. Very often, it is banking financial institutions (BFI) that have the greatest misconception of payday lenders, believing that they are predatory and take advantage of the borrowers. This mistaken belief can lead to banks considering payday lending firms as a liability rather than a potential valued client.
Proceed with caution when working with a payday loan lender
Payday lenders offer their customers short-term unsecured loans with high fees and interest rates. This type of loans is also referred to as deposit advance loans or payday advances. They are forms of credit that some customers may prefer for a number of reasons, including a situation where they cannot qualify for other credit sources. The borrower usually has to repay the loan back on the next payday. Which is why the loan is quite aptly called “payday loan”. This means that the application process usually includes a history of payroll and related employment records.
A growing number of payday lenders provide payday loans online. Consumers can even obtain a loan and authorize the repayment of its amount and fees during the same online session. A typical online payday loan scenario may go like this: the borrower obtains a loan and provides the lender with authorization to send Automated Clearing House debits to the consumer’s account at a later date for repayment. The payday lender’s bank originates the debits using the ACH network. Other payment options include wire transfer and remotely created checks.
Currently, both state and federal regulators are focusing on the payday lending industry in order to protect consumers from possible illegal payday loans. Payday lending practices are most commonly regulated at the state level. Some states completely prohibit payday lending while others have higher requirements towards lenders such as they have to be licensed and comply with maximum fees, loan amounts and interest rate caps, among other restrictions. The federal level regulations include the Dodd-Frank Act that has given the Consumer Financial Protection Bureau the authority to work against deceptive and abusive practices by payday lenders.
Payday lenders’ banks should bear in mind all the risks involved when working with online payday lenders. And such banks should make sure to incorporate due diligence techniques and to use all the available tools.
Reputation is of utmost importance
A high risk for established banks institutions is the reputational one. A payday lender’s bank should be aware that a business relationship of this type that includes ACH origination activity and a company making illegal payday loans can damage the institution’s image. The bank’s image can suffer even if the institution is not complicit in the illegal activities of its customer. But once the established financial institution determines that facilitating the payments of online payday lenders falls within its risk management model, it should ensure that it follows all applicable laws and regulations. One way to determine whether the AHC customers’ activities remain within the bank’s risk management model is to provide periodic reports on ACH customers to the bank’s board of directors. It is crucial for the bank to protect its own reputation as that affects every part of its business.
It is also important to know your clients and their practices
A bank working with payday lenders should also develop and follow adequate due diligence procedures. Both ACH rules and regulatory guidance require that banks perform “know your customer” (KYC) due diligence. These procedures include a variety of activities such as assessing the nature of the online payday lender’s activities, setting appropriate restrictions on the possible types of entries and exposure limits for the lender, and monitoring origination and return activity.
Due diligence steps usually consist of identifying the business’s principal owners, reviewing ratings for the business from various sources such as the Better Business Bureau, consumer complaint sites and credit service companies. They also include determining whether there have been recent legal actions against the business. Thoroughly reviewing the lender’s website, including the terms of the consumer’s authorization agreement and promotional materials, is advised. These due diligence practices on an ongoing basis for all merchants, not only online payday lenders, help the bank with choosing and using appropriate restrictions for the customer and therefore mitigate the risk of the bank discovering a problem when it is too late.
Being proactive is necessary to avoid problems
Banks can develop all kinds of tools that can flag potential problems in-house or can obtain them from other sources like vendors, ACH operators or NACHA. Additionally, incorporating a process to monitor transactions and returns can be used to identify anomalies, such as, for example, a sudden uptick in returns or an unusual increase in origination levels or average dollar amount. Detecting anomalies can be a sign to conduct further research on a customer.
Other tools can be NACHA’s originator watch list and vendor-terminated originator databases. They can help banks identify customers that may warrant additional scrutiny. Banks also conduct periodic audits in order to identify rules compliance issues.
For a bank, protecting its reputation is of utmost importance when it is considering offering payment services to high-risk originators like online payday lenders. The bank should proceed with caution when performing risk-based due diligence on new customers. After that, it should diligently monitor current customers so it can identify problems early and address them on time.