More welcome protections for overdraft loans, but not enough for bank payday loans

We’ve been pushing for stronger protections on overdraft protection loans for years, and the Office of the Comptroller of the Currency (OCC), a federal bank regulator, recently released a proposed guidance that would eliminate some of the worst features of overdraft programs-such as ordering transactions to maximize fee income.  However, the proposed rule has a glaring flaw—it puts  bank-based payday loans, also known as deposit advance loans, in the same category as overdraft loans. Bank payday loans and overdraft loans are entirely different beasts—they’re structured differently, used for different purposes, and have different risks. The two products need regulations tailored to their unique characteristics. We recently submitted our comments on these rules; you can send regulators your thoughts until August 8, 2011.

Both overdraft loans and bank payday loans are credit products offered by banks, but overdraft loans operate within more clearly proscribed limits than do bank payday loans. Consumers can’t simply walk into a bank branch and request an overdraft loan; overdraft loans happen automatically made when account holders make a transaction that pushes their balance below zero. Bank payday loans, on the other hand, have much more in common with high-cost short-term loans made by payday lenders, similar to those companies that have been included in our research on payday installment loans. Bank payday loan borrowers should have protections similar to those afforded to borrowers who take payday loans at nonbank institutions. By addressing bank payday loans under the same umbrella as overdraft loans, the proposed guidance ignores many issues that could pose significant risks to borrowers and banks alike.

Some ways that the OCC could better address the risks associated with bank payday loans are:

Eliminate balloon payments. Balloon payments require borrowers to pay off the entire principal in a short period of time. When that happens, borrowers are left with little income left over to meet daily expenses, increasing the likelihood that borrowers will need to take out another loan to get by and the risk that banks won’t be repaid.

Consider a borrower’s ability to afford the loan-not just the bank’s ability to collect. Currently, banks consider only the amount and frequency of a consumer’s direct deposits when deciding whether or not to issue a bank payday loan. This strategy fails to consider the total size of a borrower’s debt load and how that influences his or her ability to repay the loan. Banks should examine total debt-to-income ratio in their underwriting process.

Bring interest rates in line with comparable bank-based products or the FDIC guidance on small dollar loans. The interest rate on bank payday loans typically exceed the rates of even the most expensive credit card advances. Exorbitant interest rates increase the likelihood of a borrower defaulting on a loan. Banks should limit the interest rate of bank payday loans to the rate of comparable credit card cash advances or products based on the FDIC guidance for small dollar loans. Additionally, banks should disclose the annual percentage rate and finance charges of bank payday loans.

You can read more recommendations on proposed regulations for bank payday loans and overdraft loans in our comment letter. We urge you to review the proposed guidance and send in your own comments by August 8, 2011. Submit comments to regs.comments@occ.treas.gov with the subject line that includes “Docket ID OCC-2011-0012.” If you have any questions about the proposed guidance or how to submit comments, please contact Tom Feltner at tfeltner@woodstockinst.org or 312-368-0310.