New York Goes After Payday Lenders' Misuse of Debit Cards

New York state is cracking down on online lenders that, it says, are using debit card transactions to skirt payday lending laws.

Payday lending is prohibited in New York, and the state's Department of Financial Services has followed the Justice Department's "Operation Choke Point" tactics by working diligently to cut off offenders' access to payment services.

"My administration will work tirelessly to stay one step ahead of online payday lenders that try to evade state law and trap consumers in a vicious cycle of debt,” says New York Governor Andrew Cuomo in an April 30 press release.

The NYDFS sent cease-and-desist letters to 20 additional businesses—55 in total—that it says are making, collecting on or promoting payday loans to New York consumers. Twelve of the companies appear to be using the debit card tactic to get around state laws, it says.

Online payday lenders have previously used automated clearing house transactions to collect loans, but after the Justice Department and several states came down on banks to stop ACH originations from lenders operating illegally, the banks began cutting off all lenders, including some operating legally.

So lenders have begun requiring that customers provide them with debit card numbers to collect payments as debit card transactions, says Terry Maher, an attorney at Baird-Holm LLP in Omaha, Neb., in an interview.

The NYDFS will work with Visa and MasterCard to stop illegal activity over the debit networks.

“By working with us to root out this illegal conduct, Visa and MasterCard have stepped up to the plate and shown how private companies can work alongside state government to protect vulnerable New Yorkers," says Cuomo in the release.

When Visa or MasterCard receive an alert that a lender may be operating illegally, "they'll look to see who the acquiring member institution is that's providing processing…and those entities will close the merchant accounts," Maher says. "Acquiring banks don't want to go through the process of finding out whether all the practices of one payday lender are legal or illegal…so these merchants will go from the high-risk category to the banned category."

Also, business account applications from new payday lenders are likelier to be rejected, says Maher.

This is similar to what happened after banks were told to crackdown on ACH payments by payday lenders.

"The amount of risk the bank takes if they're providing services for someone operating illegally compared to the amount of revenue they get from these merchants isn't worth it," Maher says. Banks aren't going to hire more employees or purchase additional systems to monitor every transaction, he says.

While the NYDFS will provide information to the card networks about businesses that may be acting illegally in New York, Maher says, acquiring financial institutions will not wait for word from the NYDFS and will start dropping payday lending businesses immediately. 

The investigations are also making it more difficult for legal payday lenders to operate, with the unintended consequence of cutting off the underserved from small dollar short-term credit, says Maher. "It will force [the underserved] to go back to friends and family and other places that offer services referred to as loan sharking," he says.