Guidelines For Cash AdvancePurpose
The purpose of this guide is to provide the customer cash advance information, as well as supplement a previous program guide. Safety and soundness are described in detail as well as various compliance laws. Factors concerning the considerations for supervising state non-member institutions, and ones that implement cash advance programs are examined in full.
This guide is important because of the very high risk that is associated with receiving a cash advance, as well as the growing nature of the issue. Details will be given about the FDIC's role in risk management practices for cash advance companies, with close attention paid to concentrations, capital, loans, and loss of lease. Guidelines stated in this article also look at recovery practices, recognition of income, and the risks that are associated with third-party relationships. The protection of consumers is also fully addressed.
Corrective actions must be taken if those who examine the cash advance lenders find that safety or compliance risks are deficient. There may be a formal hearing or informal enforcement needed if this is the case. If serious problems arise, then the correct actions may be taken by law enforcement to discontinue the cash advance practices.
Cash advance lenders have recently expanded what their risk selections standards need to be, in order to attract better loans. A cash advance loan is not only offered among various types of subprime loans, but it is also being offered by many more insured depository institutions.
Cash advance loans, which may also be referred to as a deferred deposit advance, are short-term loans that are paid back from the borrower. This advance is then promised to be paid back either from the borrower's next paycheck or other regularly scheduled income. An example of this type of income would be social security. A cash advance is typically priced at a dollar fee that has been previously fixed; this represents what the borrower needs to pay back in loan fees. The APR, or annual percentage rate, is very high with these loans because they take such a short time to mature.
When a loan is taken out, the borrower typically gives the cash advance lender a personal check or a debit authorization for the loan amount, plus the fee. If it is a check, the borrower post-dates a personal check, or gives the lender authorization to debit withdrawal for what the loan amount will be, plus applicable fees. If it is a check, then the lender agrees not to cash it until a later time as per agreed, which is usually 2 weeks or less ahead. When the loan becomes due, the lender can then collect on the loan by cashing the check or debiting the borrower's account. The borrower can also have the option of bringing back the cash they borrowed and getting the check back. If the borrower does not have the money to repay the loan, many cash advance companies will give the option of refinancing the loan and charging an additional fee, giving the borrower extra time to repay the money. If the borrower doesn't come and get the check and the loan becomes due, the lender then deposits the check or goes through with the debit authorization. An NSF charge can also be imposed on the check or the debit if it comes back for non-sufficient funds. A debit withdrawal or personal check that comes back unpaid to the lender may also impose a returned item fee, as well as other collection charges.
Those who need to use the services of a cash advance lender usually have problems with cash flow. They also do not typically have any other course of action in getting a loan. Another risk of cash advance loans is that many cash advance lenders do not check into the borrower's history of being able to pay back the loan. They simply want a current pay stub, or even just proof that the borrower has a regular income source and checking account, before financing a loan. Some cash advance lenders may use types of scoring models, as well as checking nationwide databases that can trace any bounced checks the borrower may have. Another popular reason for the usage of cash advance companies is that they do not check the national credit agencies in order to secure a loan. These companies include Equifax, Experian, and TransUnion. A credit history is generally not taken out on a borrower's history. All these factors combined, such as the limited financial capability of the borrower, credit that is unsecured, as well as the underwriting analysis of the person who is borrowing the money, pose a large credit risk for the cash advance company.
An insured depository institution might have cash advance programs that are administered on their own, or they may also use their own employees. A third option would be to use third parties to enter into an agreement. If a third party is used, then the institution will usually enter an agreement where they will fund the cash advance through the third party.
These types of arrangements can also end with the sale of the third party of whatever the servicing rights are. These institutions can also depend on the third party to give out other services that a bank would not normally give out, including collections, advertising, and applications for solicitations. These types of transactions must be made with care, however, as they may improve the chances of the institution's transaction, legal and reputation risks.
A law in place by the federal government allows federal and state-chartered insured depository institutions that are making cash advances available to out of state borrowers to export the better interest rates. They must be the ones provided from the laws of the state wherever the bank happens to be located. For example, a bank that is state chartered may charge out of state borrower's interest at the rates that their bank allows, no matter what the usury limits that the state laws of the borrower's own state's residence allows. Reputation risks are at stake when an institution enters into various arrangements with cash advance lenders. These arrangements include the practice of imposing terms on cash advances that are not typically offered directly from the cash advance lender.
A cash advance is a special type of lending practice that is not usually found within state non-member institutions. They are usually frequently originated by special non-bank firms that will be subject to state regulation. A cash advance loan can also be the target of higher risks of transaction, since there is typically a large volume of loans, as well as the handling of the documents. The movement of funds from the loan between the institution and any third party originators can also be affected. Cash advances are also sometimes underwritten off site, so the risk of employees or lender agents misrepresenting information is heightened, as well as the increased credit risk that comes from not sticking to the established guidelines for underwriting.
An examiner should use this guidance for any banks that have cash advance programs which are administered directly, as well as those that are administered from a third party contractor. This guide does not, however, apply to banks that make lower amounts, short-term loans to their customers.
In the 2001 Subprime Guidance, a program was described. This would involve the regular originator of loans, the use of tailored marketing, underwriting standards, and different risk selection. In the 2001 Subprime Guidance, these apply directly to institutions that have programs where the credit exposure is at least equal to or greater than 25%, or even more than Tier 1 capital. Nevertheless, the significant credit, operations, legal, and reputation risks that are known throughout the world of cash advance lending all play a factor in whether a cash advance program is meeting their credit exposure threshold.
Any and all examiners need to use the outlined procedures that are found in the Subprime Lending Examination Procedures, and also those that are described in this guide. There are parts of the Subprime Lending Examination Procedures that are focused on safety and soundness, and there are parts of it that are aimed at compliance examinations. These need to be supplemented alongside the existing procedures that are in place for the protection of consumers and the laws. Because of the larger safety, soundness, and compliance risks that are posed by cash advance companies, risk management should always be one of the most important factors in helping consumers, and should override recourses and scheduling issues. All cases should have an extensive review of the examinations, and the papers issued should always be included within the pre-examination process. State examinations that are relevant to the case should also always be looked at.
Where it is needed, examinations of any third parties involved should always take place. The authority to conduct these types of examinations might be established within a few different circumstances. These may be included in section 7 of the Bank Service Company Act, or even through the powers that are granted under section 10 of the Federal Deposit Insurance Act. There are many third party activities that may be examined, which are not limited to the following: reviews of staffing and compensation for said staff, pricing and marketing strategies, management information systems, and also whether the company is complying with state laws and regulations. These reviews can also include the testing of individual loans to be sure they comply with underwriting and the loan administration guidelines, actions to be taken on delinquent loans, and re-aging and cure programs.
Third Party Relationships And Agreements
It is important to understand that just because a third party is used, they must still be conducted and managed in a safe and sound manner, and must comply with all rules and applicable laws. Actions may be taken against third-party relationships in the form of corrective actions, including the use of enforcement actions, if the third party is found to bear concerns about the safety and soundness of the program they are funding.
The biggest concern of the FDIC is that risk management is taken care of. Any examiner should closely look at the institution's effective risk management procedures concerning third-party cash advance companies. Any assessments of third-party relationships may include the following: risk assessment of the bank, strategic planning, and the banks diligence when they choose a third-party provider, one that is hopefully competent and reliable. (Check the
Subprime Lending Examination Procedures for more information on strategic planning and its due diligence.)
Upon examination, it should be noted that the third party should be guided by a written contract, as well as approved by the board of the institution who has taken on the responsibility. For a few examples, the arrangement should:
Provide a clear and precise description of the responsibilities and duties of the parties that are involved, the scope of the arrangement, performance measures and/or benchmarks, and the practice of providing and receiving information;
Provide written specifications showing that the third party must adhere to all laws and regulations. Specifications on which party provides the consumer compliance related disclosures. The authorization of the institution that they may monitor the third party, as well as periodically review and verify that all laws, rules, and regulations are being met and complied with.
Allow the institution as well as their bank to receive access to the third party records, and allow them to conduct on the spot transaction testing and operational reviews at third-party locations. These can be done whenever it is deemed appropriate and necessary;
Require the third party to secure against loss or damage with the institution resulting from the actions of the third party in regards to the cash advance lending company.
Take care of all customer complaints, which may include any responsibility for third-party forwarding and the concurrent response to such complaints.
When an examination takes place, examiners must also be sure that the management monitors closely the third party's activities as well as their performance. Management should also employ enough staff that has the experience to monitor the third party. The bank should have an oversight program that monitors the third party's financial condition, the controls of the party, and the service and support quality. Close attention should be paid to how consumer complaints are handled, as well. An oversight program should have the adequate documents to completely facilitate the monoriting and the management of any and all risks associated with the third party.
Safety And Soundness Issues
Because of the risks that are associated with cash advance lending, the credit that is given out in this business always poses quite a safety and soundness concern. Within these guidelines, a concentration would be understood as a large amount of cash advance loans that make up 25 percent or more of a bank's Tier 1 capital. When these concentrations are noted, the bank management should be the one at fault for the failure to diversify the risks associated with cash advance lending. Those who do the examinations will be working with the institutions individually and case-by-case to come up with any necessary supervisory actions that may be necessary to address concentrations. This action may involve pushing the institution to lower its loans to a level that is appropriate, raise additional capital, or come up with a viable plan to achieve that compliance.
The minimum capital requirements that the FDIC wishes to maintain usually apply to portfolios that show a much smaller risk profile, as well as being subject to stricter underwriting procedures than those that typically exist within cash advance companies. So, just because there are minimum capital requirements does not mean that they are enough to offset the risks that are associated with cash advance lending.
As it is written in the 2001 Subprime Guidance, the examiners should expect that an institution hold their capital against subprime portfolios. This amount should be one and a half to three times more than what is normal for non-subprime assets that are close to the same. But, since cash advance lending is about one of the highest risk subsets for subprime lending, it should be noted that more levels of capital should be started out with to begin.
According to the 2001 Subprime Guidance, any institutions that go for the higher risk subprime pools when underwriting; for example, cash advance loans, should start out at higher levels of capital. A good example of what should be started at is 100% of whatever the loans outstanding dollar-to-dollar capital is, although this depends on the level and volatility of the risk, as well. There are many risks that one must consider when the capital requirements are determined, such as the unsecured nature of the credit, the default risks from the borrower, losses gained in the event of a default, and the level of assets claimed. An examiner should also look at the degree of legal or reputational risks that are associated with cash advance loans, especially when it comes to the third-party involvement.
Examiners need to document and reference each and every institution's capital evaluation when they write up the report regarding capital adequacy. This is especially important because of the high risk of funding cash advance loans, and the impact that they have on an institution's overall capital. For more information on capital expectations, please refer to the 2001 Subprime Guidance.
Allowance For Loan And Lease Losses (ALLL) Adequacy
All examiners should make sure that institutions maintain an ALLL in their portfolio, otherwise known as an Allowance for Loan and Lease Losses, that is adequate enough to take care of the estimated credit losses that happen within the cash advance company portfolio. This is consistent with the Interagency Policy Statement on Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Associations (Interagency Policy statement on ALLL), as the term "estimated credit losses" is in reference to the amount of loans that will not be collected upon. These loans then become the net charge-offs that should be recognized within the portfolio, given all the facts and circumstances. It is imperative to note that just because the typical contract time of a cash advance loan is short, they do become longer because of renewals and rollovers. Also, institutions should also take into consideration what the collectability of accrued fees and finance charges are on cash advance loans, and make sure the proper steps are taken to measure the income appropriately.
Those who examine the cash advance companies should make sure that these institutions have methodologies as well as analyses in place that demonstrate that the level of the ALLL is right. One way to determine what ALLL needed for loans is to apply the historical loss rates to the portfolio, to get a guideline about what's to come. These factors will include current trends in delinquencies and charge-offs, trends in the volume of the loans, changes in risk selection, and underwriting practices. Economic conditions are also a factor that needs to be analyzed, as well. If a cash advance company is just starting out and does not have their own loss experience, it may be wise to take a look at other cash advance loss situations to get a feel for the situation. There are other methods available, such as loss estimation. That can work as long as they estimate losses accordingly with generally accepted accounting principles. All examiners should examine the documentation to determine if the institution's loss estimates and allowance methodologies are in sync with the Interagency Policy Statement on ALLL.
According to the Uniform Retail Credit Classification and Account Management Policy (Retail Classification Policy), there are general classifications set aside for consumer loans that have become delinquent. This Act also grants the examiners the ability to classify loans from individuals that may exhibit signs of weak credit status, whether or not they are actually in delinquent status. Examiners are also permitted to look at retail portfolios where the underwriting standards are weak, and classify account management practices that appear to be deficient.
There are many weaknesses that a cash advance company has that can jeopardize the debt's liquidation. These weaknesses can include a small analysis, or even none of the repayment capacity of the borrower and the credit being unsecured. Cash advance portfolios are also characterized by many borrowers who have paying capacity that is shaky. A portfolio for a cash advance should be classified as Substandard.
Additionally, cash advance loans that are outstanding for a long time have typically a higher risk of loss associated with them. These loans may have a recovery value, but not enough to defer writing off these mostly worthless assets. If a cash advance loan is outstanding for 60 days or more, it can be classified as a loss. There may be times when an earlier write-off is acceptable, such as when the bank doesn't renew the loan after the first payday, or the account has been closed. Then, a loss can be written up earlier.
The Retail Classification Policy should be referenced when the classification of cash advance loans takes place. Examiners do not typically classify loans if the borrower has shown adequate paying capacity and enough collateral or credit protection to pay back the loan on time.
Renewals / Rewrites
Guidelines for extensions, deferrals, renewals, or rewrites of closed-end accounts can be found within the Retail Classification Policy. Even though a cash advance is short term, a borrower should show a willingness to repay the loan if they ask for an extension, deferral, renewal, or rewrite. Under the Retail Classification Policy, the standards of the institution should be as follows:
Limit the number of times a borrower can request an extension or the like, deny additional cash advances with the intent to pay unpaid interest and fees, multiple loans at the same time to the same person, as well as make sure that proper risk management, reporting, and internal control measures are taken care of.
Institutions Should Also:
Maintain a "cooling off" period between the cash advance loan payment date and the time that the borrower can apply for another loan. This can help the borrower stay out of serious debt.
Establish a maximum amount of loans that a borrower can get within a certain timeframe, and
Make sure that no more than one cash advance loan is out with the bank to one person at a time.
Accrued Fees And Finance Charges
There is a portion of cash advance loans that has accrued interest and fees that is not collectible. Income from the borrower should be measured before a cash advance loan is given out. These methods can involve providing loss allowances over uncollected fees and finance charges, or putting a loan on nonaccrual status, meaning that subsequent fees and finance charges on the borrower won't be recognized in income and accrued.
When a loan is charged off, any more collections on it still need to be reported, typically as recoveries, to the ALLL. There are some cases where the total amount that has been credited to the ALLL as a recovery actually exceeds the amount that had been charged off. This will understate an institution's net-charge off experience, and show what the credit quality is in the portfolio of the institution.
Any monies that are collected against an account that was charged off must be credited to the ALLL as a recovery on the loan. If the amount collected is more than the original charge off, this should be classified as income to the company.
Cash advance practices raise many customer protection issues as well as attracting much attention from consumer advocates, and have an increased potential for litigation. It does not matter whether state law classifies these types of transactions as loans; they are still characterized as extensions of credit, and garner many different laws and regulations that scrutinize the cash advance companies.
Community Reinvestment Act (CRA) / Part 345
Under CRA regulations and guidance, a cash advance company program can affect the performance of the CRA. An example of this would be any evidence of illegal or discriminatory credit practices that do not help meet the community's needs. These examples include, but are not limited to, violations of: the Equal Credit Opportunity Act, which concerns discriminatory actions; the Truth in Lending Act, in reference to disclosures of loan terms, and the Federal Trade Commission Act, which references unfair and deceptive acts within a company. Illegal credit practices are what affect a CRA performance the most, which can also result in a lower CRA rating altogether. FDIC examiners must follow the CRA rules and regulations issued by the other federal banking agencies, which include the FDIC, Federal Reserve, OTS, and OCC.
There are other questionable cash advance practices that happen that may not be prohibited by law, but are nonetheless not helpful to meeting the community's needs. An example of this would be the practice of giving a cash advance to an individual who does not have the ability to repay it, which then usually results in renewals and extensions, in turn racking up fees for the company. The CRA Public Performance Evaluation should include a full description of cash advance loan programs, business strategies, product offerings, as well as any public comments that have been made about the institution. These comments should be public domain to better serve and inform the community about the practice of cash advance lending.
Truth In Lending Act / Regulation Z
The Truth in Lending Act is in place to ensure that banks that handle cash advance lending provide adequate disclosures to their customers. If a bank does not provide adequate information, such as finance charges, APR's, and other applicable and important fees to their customers, then they may be responsible for providing restitution to those consumers. This is a risk that a bank takes even if the loans are given through a third-party agreement.
TILA and Regulation Z also make sure that banks advertise their loans accurately and honestly. Advertisements must state accurate loan terms, and a term given to the borrower. For example, a finance charge must be stated as an APR, in that specific term. Any possible increases in the APR must be clearly stated in any and all advertisements. Additional disclosures on the loan products may also need to be required in any ads that are put out by the cash advance company.
Equal Credit Opportunity Act / Regulation B
Discrimination may occur when a bank offers both payday and other short-term lending practices that have great differences in interest rates or pricing structures. An examination should determine who the products are marketed to, the way the rates are set, and check to see if there have been or will be discrimination. Cash advance lending practices can also be susceptible to discriminatory practices in the form of discouraging potential customers and requesting unneeded information to evaluate applications using a prohibited basis. An example of this would be cash advance companies that will only give out a loan to someone who has a job, and does not take into consideration other sources of income, such as social security. This could be said to be discriminatory to those who receive public assistance.
According to the ECOA and Regulation B, there are limits to the information that can be collected from a customer who is applying for a loan. It is forbidden to refuse a loan to an individual who is otherwise eligible for it because of sex, age, marital status, etc. A state non-member bank is responsible for ensuring that these limits are indeed met.
ECOA and Regulation B also require creditors to tell their applicants if these actions have been taken against them after they have applied for credit. Timeframes and dates must be specified within the notices. They must also be given to the applicant within a reasonable timeframe.
Fair Credit Reporting Act
Any bank that is directly or indirectly involved in any type of cash advance company also takes on the responsibility of providing information to a customer if an application for credit has been declined, as well as other actions taken upon the individual. If any type of adverse action has been taken out on the consumer, then they must be told and given the name, address, and any other applicable information on the consumer reporting agency. Remember, consumer reports include information on bad check lists and databases that monitor unpaid cash advances. Teletrack is one such company, and these are considered consumer reporting agencies. If a third party takes adverse action, and they are not a consumer reporting agency, then information to the consumer has to direct the individual to the bank, instead of the third party.
Electronic Fund Transfer Act (EFTA)/ Regulation E And Truth In Savings Act (TISA)
If a cash advance company requires that the consumer open a deposit account or establish some type of electronic funds transfer, then they must meet the disclosure requirements of not only the EFTA, but the TISA, as well. Examples of this can include the act of depositing the cash advance right into a borrower's bank account and then debiting the payment when it becomes due.
Fair Debt Collection Practices Act (FDCPA)
When a third party is involved in a cash advance through a bank, and the third party is the one who receives the defaulted debts on behalf of the bank, then that third party could be subject to certain instances of the FDCPA. The bank may not be subject to the FDCPA, but if the third party violates their terms, then the bank's reputation could be held at stake. There should be a compliance program provided to monitor collection activities that can include collection calls and mailings.
Federal Trade Commission Act (FTC Act)
In Section 15 USC - 45(a) of the Federal Trade Commission Act, it is noted that unfair or deceptive cash advance trade practices are indeed illegal by law. Any non-member banks of the state and all institution-affiliated parties can be cited if they violate any of these acts, as well as appropriate actions taken by the FDIC. Examiners should always be on the lookout for deceptive cash advance practices, and look for abusive practices within the company. One such example is those that threaten and pursue criminal bad check charges to their customers, even when the lender gave out a loan with the knowledge that the borrower had insufficient funds to pay on it. Any incidences of unfair or deceptive trade practices may result in consultations with regional offices, which in turn may contact those in Washington.
The FDIC also monitors those entities that perform deceptive or unfair trade practices that are not just a bank, and coordinate their findings with the Federal Trade Commission.
Privacy Of Consumer Financial Information / Part 332
Any cash advance arrangements should always be subject to the same types of restrictions and requirements that other financial services are when offering their products to consumers. A bank should always make sure that a consumer is given a copy of the bank's initial, revised, and annual notices in any case where it is applicable. The bank should also be sure to protect the consumer's privacy and information, and give the consumer a privacy notice, as well.
Safeguarding Customer Information
Confidentiality, security, and the integrity of consumer information are to be protected by banks by adhering to The Interagency Guidelines Establishing Standards for Safeguarding Customer Information, Appendix B to Part 364. These guidelines are in place to assess foreseeable internal and external threats that may or may not cause problems to a customer's privacy, and should design a program that manages these particular risks. Examiners should be sure the bank is protecting the consumer's privacy and information in every way, shape, and form, be it through paper or electronic means, or any other form.