The Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) have issued new guidelines that say Advance Loan Products (issued against future paychecks for customers with a deposit account), which typically have annual interest rates in the neighborhood of 300%, are usurious. These regulations are forcing Wells Fargo & Co (NYSE:WFC), U.S. Bancorp (NYSE:USB), Fifth Third Bancorp (NASDAQ:FITB) and Regions Financial Corporation (NYSE:RF) out of the business. While the rates certainly do sound outrageous, Rafferty Capital Markets, LLC vice president of equity research Richard X. Bove thinks these new regulations will only push distressed households into the arms of loan sharks.
FDIC’s new rule meant to keep people out of the cycle of debt
“If one makes the assumption that the households who are using these programs are borrowing because they actually need the money,” writes Bove, “then the next study that has not been made would be focused on where the troubled household will get the funds if they cannot borrow from the banks – i.e., payday loan organizations, pawn shops, the mafia, and other sources, all of whom charge rates well above the 300% at the banks.”
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The intention behind this new rule is to prevent people from falling into a cycle of debt that they can’t get out of, as more and more of each month’s payment goes to interest instead of principal. The Advance Loan Products aren’t as brutal as the payday loans that have been banned in some parts of the company, and no one is accusing the banking sector of engaging in the kind of bait and switch tactics that keep people locked into payday loans, but the goal of helping people who live month to month is the same.
Richard Bove: Eliminating banking services doesn’t eliminate financing
Bove has a valid point: the Advance Loans exist because there is a need, not the other way around. “What the regulations do is eliminate the banks from selected sectors of the financial system, it does not eliminate financing from those sectors,” he writes. “The new rule doesn’t mean that people won’t need help getting to the end of the month, it means they’ll get that help from the corner payday loan shop or worse instead of a reputable firm like Wells Fargo.”
Bove cites to other instances where banks were forced out of specific financial markets, and other less-regulated entities rushed in to fill the void. Between 2009 and 2013 the securitized debt market grew from $4 billion to $100 billion while Business Development Corporations (BDC), Master Limited Partnerships (MLP) and mortgage Real Estate Investment Trusts (REIT) are all growing to replace different types of financing that banks no longer offer.
Even if the Advance Loan Products are unacceptable on a moral level, failing to identify an acceptable alternative means cash-strapped households probably aren’t actually getting relief from usury as the FDIC intended.