A couple of months ago, we pointed out the similarities between notorious ‘payday’ loans that carry exorbitant interest rates and some short-term loan offerings by two of the countries biggest commercial lenders – Wells Fargo (NYSE:WFC) and U.S. Bancorp (NYSE:USB) - in our article U.S. Bancorp & Wells Fargo Under FDIC Scrutiny Over Short-Term Loans.
And even as the Federal Deposit Insurance Corporation (FDIC) investigates these loans, recent reports reveal that the big banks’ involvement with payday loans may be more far-reaching than what was believed initially, with these banks actually allowing Internet-based payday lenders direct access to customer accounts even in states where these loans are completely banned.  This tie-up allows the payday lender to extract dues from the hapless customer while the bank ends up making quite a bit of money by charging the customer a series of fees. The FDIC and the Consumer Financial Protection Bureau (CFPB) are currently looking into these practices by the country’s Big Four banks - Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C) and Wells Fargo (NYSE:WFC).
The Financial Watchdogs Are Clamping Down On Payday Lenders With Good Reason
The practice of payday lending – handing out loans to people who have no other borrowing options available to them by accepting post-dated checks as collateral – is inherently predatory because of the unreasonably high interest rates they carry. Payday loans that charge an annual percentage rate (APR) in excess of 500% are also not unheard of. To put things in perspective, someone taking a $100 loan at an APR of 500% for a month would have to repay nearly $142 at the end of the one-month period. In most such cases, the borrower would be unable to repay and end up rolling the amount forward – attracting hefty interest again to have the cycle repeat all over again.
No wonder 15 U.S. states have banned the practice altogether by fixing caps on the maximum interest rate a lender can demand. New York state, for example, has 25% set as the upper limit for any loan.
… But Current Laws Are Easy To Work Around
The regulators’ efforts in curbing payday loan practices have only been able to get such lenders off the street in states where they are banned – with the lenders simply shifting their business online to work outside the ambit of existing laws. And, in the process, they have actually gained the benefits of online banking services provided by the country’s biggest banks. The payday lenders now setup standing instructions with banks of people who borrow from them – in essence gaining a first right on any deposit made to the account.
And the banks are only too happy to oblige. Such a relationship allows them to go beyond the amount customers have in their accounts by providing them overdraft facilities and, in the process, pocket tidy amounts of money as insufficient fund fees, overdraft fees and other service fees. After all, as far as the banks are concerned, they are still well within their right to do so. And the situation presents them the perfect opportunity to make up for revenues they have lost in recent years over stricter regulations – something evident from the chart above which shows Bank of America’s service fees as a percentage of its total deposit base.
It is anyway just a matter of time till this lending practice is shut down altogether – legally at least. Till the time the regulators step in and make necessary changes to country-wide laws in this regard, it looks like payday lenders and banks will keep their cash registers ringing at customers’ expense.Notes: