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For more than a decade, the nation's payday lenders have battled the perception that they operate on the shadowy "fringe" of the mainstream financial system, outside the long reach of government regulators and rules dictating prudent lending.
Now, payday lenders have a powerful new ally in their quest for respectability: big banks.
A few of the nation's largest banks -- including Minneapolis-based U.S. Bancorp, Wells Fargo & Co. of San Francisco, and Fifth Third Bancorp of Cincinnati -- are now marketing payday loan-type products, with triple-digit interest rates, to their checking account customers.
Despite a chorus of protest from national consumer groups, which accuse national banks of skirting state laws that limit outrageous interest rates, the banks are in a strong position to steal a big chunk of the $35 billion-a-year payday lending market -- with its estimated $7.3 billion in fees from borrowers, say industry analysts.
Fees on the new bank products may seem punitive to some, but they are about half of what is offered at traditional payday lending outlets. Increased competition may lower those fees even more, some analysts believe.
"Despite the fact that the rates may appear mind-blowing to some, people need small-dollar loans like this -- especially now," said Richard Bove, a bank analyst at Rochdale Securities.
Indeed, throughout the recession, major credit-card issuers have been cutting limits while hiking rates and late-payment fees on riskier customers, which have made the cards less affordable. In some cases, card companies have eliminated lines of credit altogether.
Longer term, the impact of the big banks' entry into the payday lending arena could be more far-reaching. Some analysts argue it could finally vault a controversial product into the financial mainstream. It's a major reason why representatives of the payday lending industry are embracing their new bank rivals -- on the hope they will help to popularize payday loans and make them appear less unsavory to millions of potential borrowers.
"We think it legitimizes the product and makes it more mainstream," said Lyndsey Medsker, a spokesperson for the Community Financial Services Association of America, an Arlington, Va.-based trade group for payday lenders.
For people struggling to make ends meet, the bank loans may prove a more affordable alternative to traditional payday lending outlets. All three banks charge $10 per $100 borrowed, which translates into a 120 percent annual interest rate if borrowers pay off the loans in a month. Though that may seem steep, it's much lower than storefront payday lenders that charge an average of $17 per $100 borrowed -- an annual rate of about 200 percent.
"All I can say is, 'hallelujah!'" exclaimed Tony Plath, a finance professor at the University of North Carolina at Charlotte. "This increases access to loans at the lower end of the market precisely when people need it most. And it brings competition to a market that badly needs it."
'Stay the hell away'
All three banks declined to disclose financial data on the products, including how many people have signed up for them, making it difficult to gauge how popular they are."
Still, groups like the Consumer Federation of America have accused the banks of using their national bank charters to avoid state usury laws. More than 30 states have usury laws on their books capping rates on many consumer loans at 25 to 60 percent; in some cases, these laws were written in response to complaints about payday lenders. But usury laws only apply to state-chartered lenders; and U.S. Bancorp, Wells Fargo and Fifth Third all have national charters.
"To me, it seems galling that these institutions that receive so much support from the taxpayer and the U.S. government happen to operate under a weaker consumer protection regime" when it comes to payday lending, said Christopher Peterson, a law professor at the University of Utah and author of "Taming the Sharks," a book on abusive lending practices. "It's a matter of time before regulators catch on to this."
The Office of the Comptroller of the Currency (OCC), the federal agency that regulates nationally chartered banks, has already signaled its opposition to banks entering the payday lending arena.
In 2003, at a news conference, John Hawke Jr., former head of the OCC, ordered them to "stay the hell away" from the national banking system, after they began partnering with banks in order to sidestep state usury laws. The agency argued that payday lending programs posed a "reputation risk" to banks because of their high fees, and ordered the banks to stop the practice. The Federal Reserve shared the OCC's position.
OCC spokesman Kevin Mukri said he was not aware of any national banks offering payday loans. "No [national banks], so far as I know, are using them, since Comptroller Hawke came down on these things," he said. He declined to look at the products of the three banks.
"Our hope is that once these products come to the attention of the OCC, and they will act accordingly and put rules in place," said Uriah King, a senior policy associate at the Center for Responsible Lending, a nonprofit group in Durham, N.C., that advocates on behalf of borrowers.
The products are not entirely new. Wells Fargo introduced its Direct Deposit Advance product -- in which loans of up to $500 are deposited directly into a customer's account and then paid off automatically when a direct deposit is made -- since 1994. And U.S. Bancorp rolled out its product in March 2006.
Yet, several industry analysts who follow payday lenders say the banks are marketing the programs more aggressively to their customers. Both U.S. Bancorp and Wells Fargo tout the products on their websites as well as in the glossy brochures they hand out to customers opening new checking accounts.
The marketing could be a response, some argue, to recent efforts by federal regulators and Congress to limit bank fees, particularly overdraft charges. "They're trying to squeeze as many fees out of their customer base as they can while they can," said John Hecht, a financial services analyst with JMP Securities in San Francisco. "They're just trying to be capitalistic."
The same, but different
For their part, the banks have been careful to distinguish their products, including eschewing the term "payday" as they market them. And they emphasize their differences with payday lenders.
"We inform our customers that this is an expensive form of credit not intended to solve longer-term financial needs," wrote Wells Fargo spokeswoman Peggy Gunn in an e-mailed response to questions. "It is designed to help customers get through an emergency situation -- medical emergencies, a car repair, emergency travel expenses, etc. -- by providing short-term credit quickly."
There are built-in cooling-off periods for borrowers who use the loans repeatedly. And customers can't extend or "roll over" the loans because the amount owed is automatically repaid with the next direct deposit. The banks claim these restrictions make it less likely that borrowers will fall into the same sort of ruinous debt cycle that has been associated with payday lenders.
Industry analysts say the risk of default for the banks is minimal, since borrowers who sign up for the loans agree to give the banks first dibs on their next direct deposit of $100 or more. Most payday lenders, by contrast, must still rely on customers showing up with a check in hand.
"They get to charge a 120 percent interest rate on what is essentially a risk-free loan," Bove said. "It shouldn't be a mystery why banks are doing this."
Chris Serres • 612-673-4308