Payday Lending: Risky Business for Banks


Banks are aggressively seeking out products upon which they can layer charges and fees, as they try to make up for some of the income lost through recent legislation that limits the amounts they can charge for services such as checking account overdrafts and debit card and credit card transactions. Many banks, and a growing number of credit unions, are turning to payday lending, or, in banking parlance, account advance or direct deposit advance loans.

Personal loans, or loansharking?
These loans generally differ only slightly from streetcorner payday loan operations. A customer must have direct deposit, so the bank is assured that there is income, and the bank pays itself back directly from this account, whereas the borrower gives the payday lender access to his checking account. The annualized interest rate is often as high as 365% at banks, a bit lower than payday lenders' 417%.

All this sounds a bit seedy, but large and mid-sized banks are offering these loans with more regularity. Trailblazer Wells Fargo (NYS: WFC) has offered similar loans since the early 1990s, and is now looking to spread the cheer to states like Maryland, where it has not previously offered this service. US Bancorp (NYS: USB) has made such loans available to online customers since 2006, and now offers the service through branches, as well.

Less well-known banks are getting on the bandwagon, too. Regions Financial (NYS: RF) recently launched its Now Banking program, which directly targets unbanked consumers with prepaid debit cards, check cashing services, and, of course, payday-style loans. The bank says nearly a quarter of its customers currently go elsewhere for those services. Fifth Third Bank (NAS: FITB) instituted payday loans called Early Access Loans in Ohio late last year, raking in annualized rates as high as 520% in a state that caps non-bank payday loans at 28%.

Fool's take
The profit margin here is unbelievable -- a $10 fee for a 10-day, $100 loan is nothing to sneeze at -- but the dollar signs in their eyes are blinding banks to the risks inherent in this model. For one thing, many have pointed out that the underwriting aspect of these loans is dodgy at best, as direct deposits may stop at any time due to job loss or other factors.

Additionally, there is a groundswell of opposition to these loans, as evidenced by an alliance of 250 community and consumer groups that recently sent letters to federal regulators demanding an end to these short-term loans. Shortly after his appointment to head the Consumer Financial Protection Bureau, Richard Corday pledged to increase oversight of these loans. Do banks really need more bad press?

In my opinion, banks should leave this hot potato alone. There are other ways, such as pre-paid debit cards, that can help them access the unbanked and underbanked without the air of sleaziness that payday loans and similar products evince. Banks would do well to bow out gracefully from this battle.

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At the time thisarticle was published Fool contributorAmanda Alixowns no shares in the companies mentioned above.The Motley Fool owns shares of Fifth Third Bancorp. The Fool owns shares of and has created a covered strangle position in Wells Fargo.Motley Fool newsletter serviceshave recommended buying shares of Wells Fargo. The Motley Fool has adisclosure policy.
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