Prepaid Card Fees

June 20, 2012

Due to the potential for regulatory flux, banks may wish to structure prepaid card fees so that the cards do not inadvertently resemble problematic short-term small-dollar lending products.

The Issue: Short-term small-dollar lending products may include short term overdraft protection loans and payday lending.[1] Such products are expensive for the borrower and accordingly tend to be monitored closely by non-governmental organizations engaged in trying to protect the consumer. In addition to the reputation risk created by such private scrutiny, banks issuing these products risk running afoul of federal or state consumer protection laws.

Recently, a Florida based national bank raised the ire of dozens of consumer protection groups when it allegedly created a prepaid card that had features substantively similar to payday lending.[2] The bank partnered with a national payday lending chain to offer a prepaid card that (a) allowed a “line of credit” that charged 35.9% interest along with a $3.50 fee for every $28 transferred to the consumer’s account and (b) that offered “overdraft protection,” charging a $15 fee for every $100 by which the account was overdrawn. Both of these products would be repaid with the consumer’s next deposit into the account. The consumer groups alleged that the partnership was an attempt by the payday lender to abuse the bank’s national charter, and associated federal pre-emption powers, to get around Arizona and Ohio’s recently enacted laws that would have applied state usury interest rate limits to payday loans.[3] 

Some states ban payday lending, or subject it to their usury laws. In contrast, federal banking regulators prefer to mandate only adequate disclosure and consent.[4] Due to a long line of Supreme Court cases,[5] an 11th Circuit (Florida) case[6] and the Office of the Comptroller of the Currency (OCC) regulations[7] defining what charges are categorized as “interest” for purposes of usury analysis - along with the OCC’s belief that Dodd-Frank did not substantively change its pre-emption powers[8] - there is a strong case for federal pre-emption of the conflicting Ohio and Arizona laws. While some believe the OCC overstates its post-Dodd-Frank pre-emption powers - with the Treasury itself saying the OCC ran “afoul of basic canons of statutory construction”[9] - such controversy will not affect pre-emption of state usury laws. That is because Dodd-Frank explicitly preserved the National Bank Act’s authority over the “charging of interest by a national bank at the rate allowed by the laws of the State, territory, or district where the bank is located, including with respect to the meaning of ‘interest’ under such provision.”[10] 

Despite the strong case for pre-emption of the conflicting state laws, it should be noted that the OCC can pursue national banks who “rent out their charters to third parties who want to evade state and local consumer protection laws.” [11]

Short-term small-dollar lending also implicates at least half a dozen federal consumer finance laws. These federal laws will be enforced by perhaps the most important regulator, the Consumer Financial Protection Bureau (CFPB), which has only started its scrutiny. The CFPB has issued examination guidance on payday lending[12] and overdraft protection;[13] solicited comments on payday lending;[14] conducted an inquiry into overdraft practices;[15] and solicited comments on prepaid cards[16] as it prepares to issue regulations on the topics. One of many tools the CFPB could use to pursue these products is the newly created prohibition on “abusive” acts.[17] Further, the OCC is to consult with the CFPB on pre-emption determinations.[18]

Implication: Until the CFPB, federal banking regulators and/or the courts bring clarity to the regulatory issues, banks and their partners may wish to pay careful attention to the way they design, market, disclose, execute and deliver their prepaid cards, so they are not inadvertently categorized as short-term small-dollar lending products.

If a bank chooses to incorporate short-term small-dollar lending features into its prepaid cards, it may wish to assess regulatory compliance under the relevant short-term small-dollar regulatory regime as opposed to the vanilla prepaid card regime. While short-term small-dollar products are highly profitable, it may be prudent to factor regulatory uncertainty into any cash flow and revenue projections. In additional, national banks that partner with entities that market their prepaid cards may want to maintain sufficient control over the product to avoid a finding that they are “renting out” their charter to help their partner avoid state consumer protection laws. Concomitantly, the bank’s partners should be wary of these risks, as any regulatory action against the bank would affect them as well.

[1] Overdraft protection products that resemble credit card lending are generally not labeled “short-term small-dollar lending” because they can be paid back over a longer time period. See e.g. Letter from Lisa Konwinski, Assistant Director for Legislative Affairs at the Consumer Financial Protection Bureau, to The Honorable Patrick McHenry, Apr. 30, 2012, available here (Question 1).
[2] Letter from the National Consumer Law Center, the Center for Responsible Lending and the Consumer Federation of America to the Comptroller of the Currency, Re: Urban Trust Bank partnership with Community Choice Financial (Checksmart) to enable prepaid card payday loans to evade state law, May 3, 2012, available here.
[3] In general short-term small-dollar lending products have fees that, if they are treated as interest for various regulatory purposes, will exceed the relevant usury limits. See e.g. Ohio Rev. Code Ann. § 1321.35(D) and §1321.40(A).
[4] See e.g. this guidance (70 FR 9127, Feb. 24, 2005) from the federal banking regulators, this regulation (74 FR 59033, Nov. 17, 2009) from the Federal Reserve, this letter (FIL-81-2010, Nov. 24, 2010) from the Federal Deposit Insurance Corporation or this proposed guidance (76 FR 33409, June 8, 2011) from the Office of the Comptroller of the Currency.
[5] See e.g. Tiffany v. Nat'l Bank of Missouri, 85 U.S. 409 (1873), Marquette Nat. Bank of Minneapolis v. First of Omaha Serv. Corp., 439 U.S. 299 (1978) and Smiley v. Citibank (S. Dakota), N.A., 517 U.S. 735 (1996).
[6] Video Trax, Inc. v. Nationsbank, N.A., 205 F.3d 1358 (11th Cir. 2000), available here.
[7] 12 C.F.R. § 7.4001(c), available here.
[8] 76 FR 43549, 43556 (July 21, 2011), available here (“Accordingly, because we conclude that the Dodd-Frank Act preserves the Barnett conflict preemption standard, precedents consistent with that analysis—which may include regulations adopted consistent with such a conflict preemption justification—are also preserved.”)
[9] Letter from George Madison, General Counsel of the Department of the Treasury to the Comptroller of the Currency, Re: Docket ID OCC-2011-0006, June 27, 2011, available here.
[10] 12 U.S.C. § 25b(f).
[11] Comptroller of the Currency Enforcement Action, News Release 2003-06: Peoples National Bank to Pay $175,000 Civil Money Penalty And End Payday lending Relationship with Advance America, Jan. 31, 2003, available here.
[12] CFPB Supervision and Examination Manual, Short-Term Small-Dollar Lending (Jan. 19, 2012), available here.
[13] Interspersed in the CFPB Supervision and Examination Manual, available here.
[14] 77 FR 16817 (Mar. 22, 2012), available here.
[15] 77 FR 24687 (Apr. 25, 2012), available here.
[16] 77 FR 30923 (May 24, 2012), available here.
[17] 12 U.S.C. § 5536(a)(1)(B); 12 USC § 5531(d) defines the new term “abusive,” as an act or practice that:

(1) materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service; or
(2) takes unreasonable advantage of-- (A) a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service; (B) the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service; or (C) the reasonable reliance by the consumer on a covered person to act in the interests of the consumer.

[18] 12 U.S.C. § 25b(b)(3)(B).