The Department of Justice and the Federal Deposit Insurance Corp. are pressuring banks to cut ties to online lenders whom regulators suspect of shady business practices, according to five people briefed on their work.
Examiners from the FDIC have audited banks to determine whether they work with some online lenders, including those operated by Native American tribes, according to the people, who spoke on condition of anonymity because the communications with regulators are confidential. The department has issued subpoenas to banks and payment processors, leading them to cut ties to some lenders, the people said.
Jer Ayler, president of Trihouse Inc., a Las Vegas-based payday-lending consultancy, said the pressure from regulators has driven away hedge funds and private equity firms who were mulling investments in the business.
“There has been sophisticated money looking at the online lending space in the last few months,” Ayler said in an interview. “Now they’re saying, ‘Whoa, wait a minute here.’”
The regulators’ leverage comes from the need for online lenders to use the automated clearing house system, or ACH, an infrastructure used to move payments among bank accounts. Mark Pearce, director of the FDIC’s division of depositor and consumer protection, called the banks the “gatekeepers” to the ACH system at a recent congressional hearing.
Much online lending involves so-called payday loans in which a borrower agrees to repay a loan the next time he or she gets paid. Storefront versions of the business use a post-dated check to secure the loan.
Online lenders typically obtain customers’ permission to directly debit bank accounts, so cutting off access to the system that allows repayment could effectively put them out of business.
Storefront lenders made $30.1 billion of the $48.7 billion in total payday loans made in 2012, with online lenders providing the rest, according to John Hecht, an analyst with investment advisory firm Stephens Inc. The industry’s revenues were about $9.3 billion, with storefronts earning slightly more than half of that.
The FDIC has audited bank relationships with online lenders, and has told bankers that working with them may pose “reputational risks” that could harm the banks’ safety and soundness, according to three of the people.
“Based on specific facts/issues, we may work collaboratively with other regulators and/or law enforcement, as appropriate,” FDIC spokesman Andrew Gray said in an e-mail.
Adora Jenkins, a spokeswoman for the Department of Justice, didn’t immediately respond to a request for comment.
The FDIC gave regulatory guidance to banks it supervises in 2012 on processing payments, Gray noted. It specifically told banks they needed to conduct due diligence and monitoring of “high risk” merchants, including payday lenders, Gray said.
Peter Barden, a spokesman for the Online Lenders Alliance, said that the group’s members are “operating legally under the law” in the jurisdictions where they are based.
For example, some lenders operate out of the state of Delaware, where such short-term loans are legal, and use the Internet to extend the loans in other states, where they may not be legal. Others are run by Native American tribal governments, who have sovereign immunity from state laws.
“What’s really troubling is that the regulators can intimidate banks into not processing transactions because they don’t like these industries,” Barden said in an interview. “The only ones who’ll be hurt are the consumers.”
Barry Brandon, executive director of the Native American Financial Services Association, said tribal lenders comply with “all applicable federal lending laws” and the pressure from the government is “an outrage.”
“This level of unwarranted scrutiny by the federal government is unprecedented,” Brandon said in an e-mail. “While the administration encourages Native Americans to pursue economic development on all fronts, regulators are acting with a borderline obsessive desire to regulate Native American e-commerce out of existence.”
Jamie Fulmer, senior vice president for public affairs at Advance America Cash Advance Centers Inc., said his industry, brick-and-mortar payday lenders, welcomes such moves. His company, which is owned by Mexico’s Grupo Elektra, obtains licenses in each state where it operates.
“We think it’s altogether responsible for regulators to crack down on unlicensed lenders,” Fulmer said in an interview.
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