Is FDIC Waging Stealth Crackdown on Online Lenders?

WASHINGTON — Intense government scrutiny of online lenders has set off a vigorous debate about how far examiners should go in dictating limits on banks' dealings with the lenders and the firms that process their payments.

The Federal Deposit Insurance Corp. has been stepping up reviews of banks' third-party relationships just as some online lenders — which need banks to process their transactions — encounter serious questions about their sky-high interest rates and whether they need to comply with state licensing laws.

But online lenders and some Republican lawmakers say that the FDIC's enforcement efforts have gone too far. Amid rumored but unconfirmed accounts of examiners expressing opposition to payday lending, they allege that the FDIC has forced banks to cut ties with a number of firms that offer short-term loans to cash-strapped consumers.

The upshot is that some storefront and online lenders that are following all relevant laws are suddenly unable to meet loan demand, according to Lisa McGreevy, the president and chief executive of the Online Lenders Alliance, an industry trade group.

"The people who are getting cut off from banking and payment-processing services include storefronts and [lenders] who are licensed in every state," McGreevy said in an interview. "It's an across-the-board attack."

The allegations of an FDIC overreach have drawn the attention of Rep. Blaine Luetkemeyer, R-Mo., and other GOP lawmakers.

While "there are probably some bad actors out there," certain FDIC-supervised banks "have been told point blank that they need to stop doing business with online lenders, without any documented risk," Luetkemeyer said. "I don't think that targeting a particular industry for extinction is the FDIC's job."

Online lending has grown rapidly in recent years — from less than $2 billion in revenue in 2006 to $4.3 billion in 2012, according to an estimate from the investment services firm Stephens Inc.

Claims that the FDIC is cracking down on banks' relationships with short-term lenders come at a time when online lenders are under scrutiny from the Department of Justice and facing legal action in certain states — most notably New York — for allegations of usury law violations and unauthorized debits from customer accounts. The fight — which extends to lenders based offshore as well as others claiming their affiliations with Native American tribes exempt them from state laws — is complicated by vast disagreement over the businesses' state licensing requirements.

Many states say the lenders cannot operate without a state license, and in states with tight restrictions on interest rates, such licenses would be difficult for many online lenders to obtain. The confusion over how to apply various state laws to high-cost lenders has revived calls for a single interest cap for all.

"It is a very uncertain legal environment," said Nathalie Martin, a professor at the University of New Mexico School of Law. "A federal usury cap would clarify everything."

FDIC officials say they are not targeting a particular industry but rather imploring banks to be wary of potential liability from working with businesses that could face public criticism and elevated credit risk. The agency says it plans to issue guidance clarifying its supervisory approach, a move Luetkemeyer said he welcomes.

"We've seen banks that have not had systems that were adequate, either on the front end to identify whether businesses were being conducted in a legal fashion, or in terms of ongoing monitoring to ensure that that was happening over time," said Mark Pearce, who runs the FDIC's division of depositor and consumer protection.

Pearce said that the negative spotlight for online lenders alone poses risks to banks.

"Certainly over the last year we've gotten complaints from state regulators saying, 'There is online lending going on in my state and these entities are not licensed with us, and they're being processed through an FDIC-supervised institution,'" he said. "There was New York's letter to banks, and there has been litigation related to certain online lending entities about the conduct of their business. All of this heightens the risk to financial institutions in this area and we want institutions to be attentive to those risks."

The agency has urged institutions to follow guidance it revised in 2012 requiring better due diligence from banks to ensure dealings with third-party payment processors and their "higher risk" merchants do not pose liability. Such merchants can include payday lenders, debt consolidation firms, pornography businesses and others. Officials say the risks run the gamut from Bank Secrecy Act violations to automated clearing house transfers being returned to transactions outside the bank's control leading to "unfair, deceptive, or abusive acts or practices."

The bank "has to be looking at its third-party payment processor and what it's doing, and be alert for any kind of illegal or fraudulent activity running through its books that … it can be held liable for," said Doreen Eberley, director of the FDIC's division of risk management supervision.

In a recent letter responding to lawmakers' concerns, FDIC Chairman Martin Gruenberg said the agency will send a letter to banks "to make it clear that the FDIC's focus is the proper management of the banks' relationships with their customers, particularly those engaged in higher risk activities, and not underlying activities that are permissible under state and federal law."

Pearce said it "would not be FDIC policy" to view all online payday lenders negatively.

"There may be lenders that are complying with all applicable state and federal laws [that] have the sense that we have some policy that is pushing them out of the banking system," he said. "We don't want there to be any confusion about the fact that we are not seeking well managed and lawful relationships to be banned from banks."

Still, the online lending and payment-processing industries blame the FDIC for a purported uptick in banks terminating service agreements. Industry representatives, congressional staff and lawmakers have discussed accounts of meetings of banks and FDIC examiners — in which executives are said to have been told to end the relationships — but such accounts have not been reported publicly by anyone witness to those meetings.

McGreevy said the reports of FDIC examiner pressure suggest a policy of opposition to the online industry.

"It seems evident to us based on anecdotes we've received from people that it goes up to the regional offices and the regional directors. … We think it's the policy coming from Washington. I don't think it's a rogue examiner. I don't think it's a rogue region," she said.

But Pearce said a bank's decision about whether to continue to provide services to online lenders, other merchants and third-party processors rests with the bank.

"Obviously, with any banking relationship there are risks involved, and a bank may choose not to have a relationship with certain business lines. But from the FDIC's standpoint, that's the bank's decision to make," he said.

While the Online Lenders Alliance objects to the aggressive stance taken by state and federal authorities, it has also urged lawmakers to create a federal payday lending charter to clarify licensing requirements.

McGreevy said lawmakers debating the 2010 Dodd-Frank Act took the approach that the payday lending industry, which includes online lenders, should be properly regulated, but not forced out of existence.

"There is no federal law that prohibits online lending. And there is no federal usury limit — Dodd-Frank settled that," she said.

In one example of a bank ending its relationship with an online lender, American Web Loan — a short-term lender affiliated with the Otoe-Missouria Tribe of Indians — was informed by Missouri Bank and Trust Co. of Kansas City last month that the bank would cease providing ACH services to the lender.

But it remains unclear whether in that and other instances the FDIC forced banks to pull the plug, or institutions cut ties based on negative publicity around online lenders and the costs of enhanced monitoring.

American Web Loan was one of 35 lenders mentioned in an Aug. 5 letter by New York Banking Superintendent Benjamin Lawsky asking banks in his state to "choke off" ACH access to the businesses, claiming they were illegally charging annualized interest rates above New York's 16% civil usury cap.

In an Aug. 16 letter from Missouri Bank, the bank's chief operating officer, Linda Marcum, told AWL of warnings from regulators and Nacha — the bank-owned group that runs the electronic payments network — that the bank "faces potential risks and compliance burdens as a result of providing ACH services to you and others employing similar business models." (The letter was made public by a lawsuit against Lawsky by the Otoe-Missouria Tribe of Indians and other parties.)

"There have been a number of initiatives by State Attorneys General and other enforcement officials, as well as other regulatory bodies, suggesting that short-term, payday, and Internet lenders must comply with various State licensing, usury, and other laws," Marcum wrote. "Some of them have gone so far as to suggest the Bank may be held responsible for transactions by its customers, which are found to violate State laws.

"While we understand our customers' belief that these State requirements do not apply to their activities, the Bank does not have the resources to evaluate and determine the adequacy of compliance with the various State laws of each transaction we process for each of our customers."

A spokesman for Missouri Bank declined to add comment beyond what the letter states.

One executive in the third-party payment processing industry said that government authorities have become too intrusive into transactions that consumers have authorized.

"Consumers shouldn't be taken advantage of, but as adults they should have the freedom to pick and choose products they want to use," said the executive, who asked not to be identified. "If a lender is offering this type of product, and is transparent about the jurisdiction and venue where the loan is being offered, the rate it is charging, and repayment options, and the consumer accepts that, then that's two parties entering into an agreement."

The FDIC's 2012 guidance alluded to certain extreme cases where higher-risk businesses seeking access to the payments system have attempted to attract troubled community banks with promises of capital infusions and high fee arrangements.

"We believe there are actors who are trying to develop relationships with smaller community banks that may be struggling financially, taking advantage of their lack of oversight and monitoring. Those actors have gotten increasingly sophisticated," Pearce said.

Other groups representing short-term lenders have voiced their criticism in more measured tones than the Online Lenders Alliance, but they too are troubled by rumors of FDIC examiners pressuring banks to sever or scale back relationships with lenders and payment processors.

"We have not heard of specific examples, only rumors, that regulators were either directly or indirectly discouraging banks from stopping ACH," said Amy Cantu, a spokeswoman for the Community Financial Services Association of America, a trade group representing small dollar, short-term lending and payday advance providers. "These are certainly troubling rumors, and if true, they indicate that the FDIC is engaging in overly broad regulatory actions."

Unlike some online lenders, all of CFSA's members hold licenses in all of the states in which their borrowers reside, according to the group.

One of CFSA's member companies, a storefront payday lender that does not offer online loans, recently received a termination notice from its payment processor, but the issue was quickly resolved, according to Cantu. She says that news coverage of the crackdown on online payday lending may have had a "chilling effect" on the payment processor.

Barry Brandon, executive director of the Native American Financial Services Association, which represents online lenders that claim tribal sovereignty, said that his organization has expressed its "concerns" to FDIC and DOJ officials that the government's actions are having unintended consequences. Some banks are reported to have received DOJ subpoenas related to their providing services to online lenders or third-party payment processors.

National Bank of California in Los Angeles, disclosed on Sept. 16 that a $25 million recapitalization is contingent on resolving pending inquiries by the DOJ regarding its relationships with companies that may have processed payments for payday lenders.

"I'm currently trying to work out a settlement," Henry Homsher, the president of the $342 million-asset bank, said in a brief interview, declining to comment further.

It is not the first time a bank regulator has taken an interest in institutions' dealings with payday lenders. In 2006, numerous banks stopped direct offering of payday lending products. Then, too, the FDIC's influence was cited. Before that, other agencies took an interest in banks' dealings with short-term lenders.

"The FDIC is trying to demonstrate to banks that the online payday lending industry is fraught with risk. It's not such a different motivation from what has been a historical position by bank regulators about regular payday lending when there was a concern that some banks had more direct partnerships with payday lenders," said Richard Riese, a senior vice president for the American Bankers Association.

But Riese said the FDIC could attract criticism for focusing on transactions to which the bank is not a direct party.

"The current situation flows from the fact that these lenders are often customers of the bank, or customers of the customer of the bank. All the bank is doing is providing a bank account just like it provides a bank account to any business. There is no true aiding and abetting going on," he said. "The FDIC is reflecting a sincere interest in the protection of consumers. But there is a slippery slope when you exercise that judgment because it invites judgments about what businesses you're going to seek to protect consumers from, including legal businesses."

Consumer advocates say regulators should be vigilant about banks associating with various types of short-term lenders — not just to protect consumers but to shield the bank from risks as well.

"The ongoing concern that we have is, as these payments are processed by banks, by payment processors: are they putting financial institutions at undue risk?" said Tom Feltner, director of financial services for the Consumer Federation of America.