CFPB Proposes Rule To Close TILA Overdraft "Loophole"
Latest In Synapse v. Mercury; Robinhood Settles with Massachusetts; Normalize Using The Discount Window, Hsu Argues
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CFPB Proposes Rule To Close TILA Overdraft “Loophole”
Last week, the Consumer Financial Protection Bureau issued a new proposed rule that, in its words, would close the “bank overdraft loophole that costs Americans billions each year in junk fees.”
The development isn’t entirely surprising; the CFPB has been pushing banks, especially the country’s largest, to rein in “junk fees,” including fees for overdrafts, non-sufficient funds, minimum balances, and the like. And the Bureau’s efforts seem to be working, with aggregate revenue from overdrafts and NSFs across the banking industry down substantially in 2022:
The new proposed rule goes substantially further, however, and would require covered banks — those with $10 billion or more in assets — to treat overdrafts akin to traditional credit products, like credit cards and personal loans, though with some exceptions.
According to the CFPB’s fact sheet on the proposed rule, that would mean complying with the requirements of the Truth in Lending Act (TILA) and its implementing regulations, Reg Z. Compliance with TILA would require covered banks to treat overdraft fees as “finance charges” and disclose the applicable APR.
Given the typically small size of overdrafts, relatively high fees as a percent of the amount of the overdraft, and short duration (on average three days), APRs, which calculate the cost of credit on annualized basis, for overdrafts can easily exceed 10,000%.
In justifying the need for the proposed rule, the CFPB argues that overdrafts evolved from an ad hoc courtesy banks would provide to allow customers to avoid bouncing a check to, in some cases, a form of short-term credit for account holders — and major revenue pool for banks.
The rule includes a carveout for banks that charge an overdraft fee in line with the actual costs of providing overdrafts. The CFPB proposes two mechanisms for establishing that amount: either an individual bank could calculate its own actual cost, or use a CFPB-establishment benchmark, which the Bureau proposes being somewhere between $3-$14.
Banks offering overdrafts with fees not exceeding one of these thresholds would not have to comply with TILA.
Why Exempt Banks Below $10 Billion In Assets?
If the goal is to protect consumers, why carve out banks below $10 billion in assets?
The proposed rule states that banks with over $10 billion in assets, a group of approximately 130 institutions, account for 68% of all overdraft fees paid by consumers.
The proposed rule’s justification for not extending the rule to smaller banks is exceedingly vague, saying, “In light of the different circumstances smaller financial institutions may face in adapting to the proposed regulatory framework, the CFPB is proposing not to extend the new rule to those institutions with $10 billion or less in assets.”
The reality is, although the largest banks account for the lion’s share of overdraft revenue on an absolute basis, smaller banks are actually more dependent on overdraft and other service fee revenue. The CFPB’s own rule implicitly acknowledges this, in stating that covered banks account for 68% of overdraft fees while holding 80% of consumer deposits — meaning exempt banks hold just 20% of deposits, while charging 32% of overdraft fees.
The CFPB has repeatedly decried banks’ “deep dependence” on overdraft fees, but it is actually smaller banks that are more likely to be “dependent” on this type of revenue:
Although JPMorgan Chase earned some $2.2 billion from service fees, including overdrafts, on consumer accounts in the 12 months through September 30, 2023, that accounted for just 1.5% of the bank’s operating revenue. Smaller banks, like those shown above, are more likely to derive a larger proportion of their operating revenue from such fees.
And, in fact, that may be part of the motivation not to include small banks in the scope of this proposed rule.
The carveout, preserving overdraft as a key source of revenue at some smaller banks, illustrates competing policy priorities — not just of the CFPB, but of federal bank regulators writ large.
On the one hand, regulators under the current administration have a clearly stated agenda of supporting “competition” in financial services and banking. At the same time, the granting of de novo charters has slowed to crawl. Policy on industrial loan charters (ILCs) swings back and forth with which political party controls the White House, with current Democrat-appointees apparently dead set against granting such charters.
Consumer fintech, which can both serve as a direct source of competition and provide new distribution channels and revenue sources for smaller banks, is viewed with increasing skepticism from bank regulatory agencies. For nearly four years now, no fintech that has sought a de novo bank charter has had their application approved.
Simple logistics may also play a role: by exempting banks with less than $10 billion in assets, the CFPB can avoid a required process to assess the rule’s impact on small businesses, known as a SBREFA review.
And the politics can’t be ignored either; if it’s easy to beat up on “Wall Street banks,” the converse is equally true: small banks historically have punched above their weight in influencing legislative and regulatory processes with both Republicans and Democrats.
Beware The Law Of Unintended Consequences
While encouraging covered banks to charge overdraft fees in line with their actual costs and requiring such products to be treated as “credit,” with the consumer protections that go along with that, seem like reasonable policy, there are always unintended consequences with these kinds of fee caps.
The unintended consequences of another price cap, the Durbin amendment — passed nearly 14 years ago, continue to reverberate across the US financial services landscape even today.
A fee cap on overdrafts, and that’s effectively what the proposed rule would be, won’t come without unintended consequences.
Implementing an effective fee cap on overdrafts, like any rate caps on credit products, is likely to result in a reduction of supply — banks will make overdrafts available to fewer consumers in order to reduce exposure to potential losses. I’m not arguing that this is good or bad, from a policy perspective, but rather that it is a near-certain industry response to the proposed measure.
Supply-side constraints on credit, like fee caps, are like squeezing on a balloon: they do nothing to change consumer demand for credit, and that demand has to go somewhere.
Consumers who are not eligible to overdraft are likely to turn to other forms of short-term small-dollar credit, whether classic payday loans, newer fintech “cash advance” apps (which have had their own regulatory issues), earned wage access, buy now, pay later, or other similar products.
The cost and the consumer protections of substitute products could be “better” (cheaper, safer) or “worse” (more expensive, predatory) than the overdrafts they are taking the place of.
Covered banks that see revenue from overdrafts drop are likely to look for ways to make up the difference — as was the case after the Durbin amendment. One can imagine new kinds of fees, increases to existing fees, and/or changes to thresholds that make users more likely to incur fees (minimum balance, account maintenance, direct deposit requirement, minimum number of debit transactions per month, etc.)
Finally, banks may just increasingly say “no” to certain segments of consumers who want to open accounts.
After all, it isn’t actually free to provide users with a checking account. There are very real costs to opening and servicing accounts in a compliant manner. By reducing the revenue potential tied to lower-income and lower-credit score users, and thus increasing the share of accounts on which banks are likely to lose money, banks become more incentivized to turn away poor customers — reducing the “access and inclusion” regulators so often say their policies are intended to foster.
Robinhood Says 👋 To Emojis, Confetti In Massachusetts Settlement
No-fee brokerage Robinhood reached a settlement with the Massachusetts securities regulator, finally putting the regulatory action, which dates to 2020, behind the company.
The regulatory action stemmed from allegations that Robinhood violated a state fiduciary duty that applies to brokers because of its use of “gamification” techniques, including its hallmark confetti when users took certain actions on the platform, including funding their account or making a trade.
Other “gamification” techniques cited by the regulator included Robinhood’s use of lists of popular and highly traded stocks, push alert notifications, and the offer of free stock rewards for companies such as Microsoft or Apple for new customers, when the likelihood of winning a reward of such high value was extremely low.
The Massachusetts regulator’s enforcement action also addressed multiple outages of Robinhood’s platform that negatively impacted Massachusetts users and the company’s failure to maintain and enforce reasonable cybersecurity protections, which resulted in a data breach at the company in 2021.
In agreeing to the consent order, Robinhood admitted to the factual allegations related to its cybersecurity protections; it neither admitted nor denied the other factual allegations; and it neither admitted nor denied the violations of the law alleged by the securities regulator.
The agreement requires Robinhood to:
cease and desist from further violations of relevant laws and regulations in Massachusetts
add relevant disclosures to “lists” of stocks on its platform
remove all emojis from the life-cycle of a given transaction
permanently cease use of confetti (which Robinhood did in 2021, following the initial filing of the state’s complaint)
permanently cease use of certain push notifications highlighting stock lists
permanently cease use of certain features that mimic games of chance
The agreement also requires Robinhood to review and strengthen employee system access controls and ensure the sufficiency of processes for employees to report data breaches.
The state regulator further censured Robinhood and assessed an administrative fine of $7.5 million.
Normalize The Fed Discount Window, Hsu Argues In Speech
In a speech last week at Columbia Law School, Acting Comptroller Michael Hsu used the opportunity to reflect on last spring’s banking crisis and float potential policy changes to help mitigate the risk of similar crises in the future.
Noting the role uninsured deposits played in the collapse of Silicon Valley Bank and Signature and the rapid pace of withdrawals, Hsu proposed a new “targeted” liquidity requirement he wants regulators to consider adopting.
Hsu noted in his speech that uninsured deposits in the banking system have grown at annualized rate of nearly 10%, from $2.3 trillion in 2009 to $7.7 trillion in 2022. He also commented on “herd behavior,” where a group of distinct depositors exhibit similar behavior — in this case, rapidly withdrawing funds — as a result of similar characteristics and tightly networked communication.
Acting Comptroller Hsu further points out that, in the cases of SVB and Signature, higher-risk deposits, including uninsured deposits, were treated as “retail demand deposits,” comparable to an everyday (typically insured) consumer account, for the purposes of determining the banks’ liquidity coverage ratios (LCRs).
To help address the kind of acute, short-term liquidity crisis that contributed to the spring banking crisis, Hsu proposed a targeted liquidity requirement, which could mandate midsize and large banks have enough liquidity to cover stress outflows over a five-day period.
Other ideas floated in the speech included having banks identify assets they would pledge and pre-position them, such that they could rapidly tap liquidity from the Fed’s discount window if need be. Hsu also suggested “periodically” borrowing from the Fed discount window, as a routine exercise, could “help ensure that banks are capable and operationally familiar” with doing so. Analysis of last year’s bank failures pointed, in part, to banks’ operational challenges in tapping the discount window as contributing to their failures.
Hsu also acknowledged there is a stigma attached to banks accessing liquidity via the Fed’s discount window — as the “lender of last resort,” accessing this funding can be interpreted by others in the market as a signal that a bank is in trouble. Hsu suggested options, including explicitly giving banks credit for their discount window borrowing capacity or incorporating accessible discount window funding in banks’ liquidity coverage ratio calculations — thereby making it clear that the Fed expects banks to tap these sources of liquidity, should the need to arise.
Latest Filings In Mercury v. Synapse
Okay, even I’m getting a bit bored with the back-and-forth claims in Mercury and Synapse’s dueling arbitration claims and court filings — the only thing that’s clear from the dispute is that neither side is likely to come out of it looking good.
For those who haven’t been following along, here is a very brief recap:
In October 2023, as Synapse and Evolve traded blame over allegations that as much as $13 million in customer funds were missing, Mercury informed Synapse it wouldn’t be renewing its agreement with the company, instead moving to work directly with Evolve. Synapse, apparently as a result, laid off approximately 40% of its staff.
On December 11th, Mercury filed a non-public arbitration claim against Synapse and, shortly thereafter, filed a lawsuit, seeking to freeze up to $30 million of Synapse’s assets, arguing that Synapse is insolvent. A judge declined Mercury’s initial, ex parte application for a temporary protective order and scheduled a hearing on the company’s request for a writ of attachment on 24 January 2024.
On December 28th, Synapse CEO Sankaet Pathak fired back in a blog post, calling Mercury’s claims “knowingly false.” Synapse subsequently filed a counterclaim in the arbitration case accusing Mercury of fraud and breach of contract and seeking more than $30 million from Mercury.
And last week, Synapse filed additional papers with the court, including a supporting declaration from CEO Sankaet Pathak, opposing Mercury’s application for a noticed temporary protective order, right to attach order, and writ of attachment.
Beyond arguing that Mercury’s requests should be declined because it failed to produce evidence that there was an imminent risk of Synapse’s collapse or that Mercury would suffer “irreparable harm” without relief, the most interesting new bits of information from the filings include:
In Synapse’s counterclaim in arbitration, it is seeking damages of “over $36 million on the fraud claim and approximately $5 million on the breach of contract claim,” which, Synapse argues, more than offsets Mercury’s claim (which Synapse disputes) of $30 million — meaning the amount of any attachment should be reduced to zero.
Synapse’s counterclaim argues that the change in terms it agreed to in April 2023, which increased payments to Mercury by tying rebate payments to the federal funds rate, was negotiated by Mercury in bad faith. Specifically, Synapse says, Mercury represented it would bring more deposits to the platform, negotiate towards a new Master Services Agreement, and incorporate Synapse’s cash management program into the relationship.
Instead, Synapse says, at the time the two agreed to terms increasing payments to Mercury, “Mercury intended to end its relationship with Synapse as soon as it was commercially and logistically possible for Mercury to enter a direct relationship with Evolve.”
Synapse also alleges Mercury did not meet its minimum revenue commitment, which, Synapse says, was $20 million in 2023, as Synapse met certain targets set by the agreement; accordingly, Synapse argues Mercury owes it at least $4,830,089 for breach of contract.
Synapse alleges Evolve Bank & Trust provided false information to Forbes that formed the basis of an article incorrectly describing the nature of Synapse and Evolve’s dispute.
Synapse also says, contrary to various media reports, that it continues to “serve its customers through Evolve.” Evolve Chief Marketing and Communications Officer, Thomas Holmes, Jr., and Chairman, Scot Lenoir, did not respond to multiple requests asking if Evolve continues to support Synapse clients.
Synapse also states that it “has already migrated many customers away from Evolve and has onboarded other programs to bank partners other than Evolve.”
Mercury, for its part, filed arguments in support of its motion to seal certain documents in the case; in that filing, Mercury accuses Synapse CEO Pathak of including “sealed and confidential material” in his December 28th blog post.
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