FDIC Clarifies Position on Bank Payment Processing for Payday Lenders and High-Risk Merchants

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Last week, the FDIC issued the latest in a series of Financial Institutions Letters dating back to 2008 on the subject of banks managing third-party risk. This most recent FIL deals with payment processing for third-party merchants engaged in higher-risk activities.

The FIL follows earlier guidance in setting forth the FDIC's expectation that banks providing payment processing for such merchants will perform appropriate risk assessments and conduct due diligence and monitoring adequate to ascertain whether the merchants are operating in accordance with applicable law. The FIL is an apparent response to congressional inquiries spurred by reports that the FDIC was actively encouraging banks involved in payment processing to payday lenders to discontinue providing such services. A recent letter from FDIC Chairman Martin J. Gruenberg to Congressman Blaine Luetkemeyer presaged the issuance of just such an FIL.

Without mentioning payday lending, the FIL—which applies to banks of all sizes, including community banks—emphasizes that banks "that properly manage these relationships and risks are neither prohibited nor discouraged from providing payment processing services to customers operating in compliance with applicable law." Thus, the FIL clarifies that banks can continue to assist payday lenders who have adopted a "state-by-state" model of operation and comply with the laws of the states where their borrowers reside. The FIL does not directly express a view on other models, including "tribal" models used by many online payday lenders.

The FIL asserts that higher-risk activities are typically characterized by high rates of return, high rates of unauthorized transactions, consumer complaints, and regulatory or criminal actions. The FDIC's reference to high rates of return comes amid reports that the Department of Justice is taking the position that rates of return exceeding 3 percent should raise red flags. In our view, any focus on return rates is questionable and overly broad in the context of a product serving a population with serious credit and liquidity problems.