Chime, Varo May Mislead on Overdrafts
Unclear How Many Qualify for Larger Amounts
Hey all, Jason here.
It’s Super Bowl Sunday — not a big event here in the Netherlands (doesn’t help that it’s on at midnight). The big game will feature commercials for a number of financial services companies, including trendy buy now/pay later startup Klarna and “challenger” bank Varo.
Thinking about how fintech startups are marketing themselves led me to ask myself the question, are they overpromising? This week, I look specifically at how Chime and Varo drive customer acquisition with promises of “up to $100” — and the fine print many users may miss.
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Chime, Varo May Mislead on Overdrafts
Two of the enduring claims of fintech consumer products are “no hidden fees” and “transparency.” Bonus for offering “financial education” or citing as a priority “improving financial health.”
Chime and Varo, which, combined, boast about 15 million accounts, tick all three boxes in their public positioning to consumers, regulators, and the press.
Features Targeted to Vulnerable Consumers Key to Growth
Chime and Varo both saw phenomenal growth in 2020 - in part driven by the coronavirus pandemic and the ensuing economic dislocation and government bailouts.
Both leveraged government stimulus payments as an opportunity to acquire new users and encourage existing ones to adopt direct deposit in order to access their payment up to two days early.
Consistently receiving a paycheck early arguably does little to improve a user’s financial health if it is merely pulling forward that user’s budget cycle by 2 days, but the feature holds broad appeal for low/moderate and income volatile consumers living paycheck to paycheck.
Another key feature driving growth in the low/moderate and volatile income segments? Small-dollar credit. The types of users Chime and Varo target are accustomed to being disproportionately hit with punitive fees for even the smallest overdraft with “legacy” banks like Wells Fargo, Bank of America, or Chase.
The idea of an “overdraft” itself is a legacy of the time required to physically move a paper check from a merchant to its bank, through a central clearing house, to a consumer’s bank. Nick Bourke, of consumer advocate Pew Charitable Trusts, described overdrafts as an anachronism, telling me:
“It's now possible for a bank (or neobank) to provide the innovative solution (small-dollar credit) profitably and in compliance with the law without having to cling to the anachronistic notion of an "overdraft" or a short-term 'advance.' But real innovation is sometimes hard and can take a while.”
Chime and Varo’s approach? A revamped overdraft-esque product. Chime’s SpotMe is structured as a “fee-free” overdraft, while Varo’s version fulfills the same need but is legally structured as a line of credit, not an overdraft.
Chime users may be able to overdraw by up to $100 with no fee (but an optional requested “tip”); Varo users may be able to access the same $100 but with a fee up to $5 (currently waived through Mar 31, 2021).
These formulations of an “overdraft” or “advance” are inarguably better (less expensive, more flexible) than a traditional bank overdraft or payday/small-dollar loan.
However, as both Chime and Varo have leaned into marketing these features, the aggressive marketing and potentially inadequate disclosures threaten to mislead and disappoint consumers and, possibly, bring unwelcome inquiries from newly empowered regulators.
What might those regulators look at? Broadly, there could be issues with the structure of the products themselves, as well as with how the products are marketed to consumers.
From a product design perspective, there are a number of areas that appear to diverge from typical bank overdraft programs (which, to be clear, I’m not saying are a great form of credit).
Some aspects of the product designs that might catch regulator attention:
Types of transactions covered. A typical bank overdraft program is likely to honor checks, recurring ACH debits, and recurring debit card payments (as Chase does).
Chime’s overdraft facility can only be used for debit card purchases; because Varo’s advance is paid into the account as a requested, fixed amount, it appears to be usable as normal.
Changes in the amount available through overdraft/advance without advance warning.
While bank overdraft programs typically reserve the right to approve or deny specific transactions, they don’t often market a specific dollar amount of overdraft availability.
Chime and Varo’s product structure could set users’ expectation that a certain amount is available, which Chime/Varo can lower without advance notice. Varo’s terms explicitly state they may inform a user after a change in their limit has already become effective:
“If we reduce your Credit Limit, we will provide you with notice, but the effective date of the reduction may be prior to your receipt of the notice.”
How the facility is repaid. With Chime, if the user has a negative balance, any deposit will first be applied toward that negative balance. While this is consistent with how big bank overdrafts work, it can cause hardship for low income/income volatile consumers and could draw regulator scrutiny.
This approach could cause users to repeatedly overdraft with Chime (and be encouraged to leave multiple “tips”), or cause users to incur overdrafts or late fees with other banks/creditors.
Varo, with its line of credit structure, gives users more control to make “as many payments” as they like, so long as the advance is fully repaid within 30 days.
If it is not repaid within 30 days, Varo does have the right to deduct amounts from incoming deposits - which, like Chime, could cause users to unexpectedly incur overdraft/late fees with other creditors. If users fail to repay the balance after 30 days, a negative report may be made to credit reporting agencies.
Structured as a line of credit (albeit with “0%” APR and a fixed-dollar fee) rather than an overdraft, a slew of additional regulations could apply. TILA generally defines a “creditor” as extending credit repayable in more than four installments; the structure of Varo’s advance allows it to avoid disclosures under Reg Z. Its $5 fee, if calculated as an APR on a hypothetical $100 7 day advance, would be 260%.
ECOA and FCRA, however, have broader definitions of credit. It’s unclear if or how Varo’s Advance product is complying with the fair lending and adverse action notice requirements of these regulations.
While their product designs are worthy of scrutiny, there is a more obviously problematic area: how Chime and Varo are marketing this feature.
Who Decides What is “Deceptive”?
Before we look at how Chime and Varo position and market their products, it’s helpful to have an understanding of how a regulator, the CFPB in this case, evaluates marketing claims.
The primary framework here is “UDAAP” - Unfair, Deceptive, and Abusive Practices. In this case, the “d” -- deceptive.
Under the standard, an act or practice can be held to be deceptive if:
(1) there is a representation, omission, or practice that,
(2) is likely to mislead consumers acting reasonably under the circumstances, and
(3) the representation, omission, or practice is material.
Any experienced marketer of financial services should be familiar with UDAAP and, no doubt, understands the importance of adequate disclosures in mitigating legal risk around UDAAPs.
Disclosures, though, need to be seen to achieve this. The “clear and conspicuous” standard generally calls for relevant disclosures to be conspicuous (equal prominence to claim) and proximate (near to the statement that is being disclaimed).
Further, there are specific advertising disclosures required for overdraft products, which would seem to apply to Chime’s SpotMe product; given Varo’s structure as an “advance,” it is unclear if these policies would apply. The policies call for any advertisement for an overdraft to clearly and conspicuously disclose:
(i) The fee or fees for the payment of each overdraft;
(ii) The categories of transactions for which a fee for paying an overdraft may be imposed;
(iii) The time period by which the consumer must repay or cover any overdraft; and
(iv) The circumstances under which the institution will not pay an overdraft.
Chime’s advertising has heavily featured SpotMe, which it describes as a fee-free overdraft of up to $100. These Facebook/Instagram ads -- which are still running -- are fairly representative:
These ads do mention “with direct deposit” and include an (*) - not uncommon for products that carry terms and conditions that don’t fit in the limited space offered by a Facebook ad.
In this example, clicking on the ad would take the user to a landing page like this:
The landing page does mention there are “details” on SpotMe at the bottom of the page (a full 10 screen lengths below in small, grey type on a white background) -- substantially below the call to action to apply.
If a user were to scroll down, they’d learn that not only is direct deposit a requirement, but that they must have $500 of direct deposits within ~30 days in order to qualify for $20 - not the $100 promised by the ad.
Even the disclosure on the landing page lacks key information, saying only “$500 in direct deposits a month” - without specifying that only certain kinds of deposits qualify: payroll or government benefits via ACH - not other types of ACH transfers (including from p2p apps), check or cash deposits.
The disclosure states (interestingly different landing pages have slightly different versions of this SpotMe disclosure):
*Chime SpotMe is an optional, no fee service that requires you receive $500 in direct deposits a month to qualify to overdraw your account up to $20 on debit card purchases. Chime, in its sole discretion, may allow you to overdraw your account up to $100 or more based on your Chime Account history, direct deposit history and amount, spending activity and other risk-based factors. Your Limit will be displayed to you within the Chime mobile app. You will receive notice of any changes to your Limit. Your Limit may be increased or lowered at any time by Chime.
Your typical user is unlikely to see this additional disclosure before choosing whether or not to open an account.
Chime should know this, by virtue of where it chose to place it on the page, and likely confirmed by commonly used page analytics tools that can show what proportion of users scroll far enough down the page to view the disclosures.
Could this be “deceptive”? Applying the three part framework to the ad and landing page:
Is there an omission or misrepresentation? Yes.
That is likely to mislead consumers acting reasonably under the circumstances? Yes, a reasonable user is likely to conclude it is possible to attain an overdraft of up to $100; the disclosure (which they are unlikely to have viewed) suggests that no user qualifies for more than $20 “initially.”
This omission or practice is “material.” Yes, the difference between being able to overdraw by $20 vs. $100 is material.
It’s unclear what proportion of users who meet the stated requirements end up qualifying for any overdraft and, if so, how many qualify for the advertised max of $100.
The likelihood of a user actually being able to obtain the “up to” amount is key to understanding if the marketing should be considered deceptive.
The confusion and irritation of Chime users is made clear by reviews left on its app and review sites, complaining about not qualifying for the $100 or the amount being lowered with no advanced notice.
“Free” Overdraft, Tip Requested
The claim that the overdraft is “fee-free” is true enough, though Chime does prompt the user to leave “tips” when the overdraft is cleared.
In Chime’s own example, the minimum suggested tip of $1 on an overdraft of $4.89 - if you assume a 7 day repayment period - would be the equivalent of ~1,064% APR, if Chime were required to calculate and disclose an APR.
Varo, which offers a small-dollar line of credit, refers to it as an “advance.” The company is in the midst of launching an extensive marketing campaign, positioning it as “A bank for all of us,” and will debut a TV commercial during this evening’s Super Bowl; it’s unknown at the time of publication if the ad will promote the $100 advance product.
Its advance product is heavily promoted on its site and in advertisements, including these ads, currently running across Facebook and Instagram:
The central claim - “Get up to $100 in cash instantly” - is used across a number of ad units.
An interested user who “click[s] for details” isn’t taken to any context or clarification on the requirements or conditions for this feature or to Varo’s site at all - they’re taken directly to the Google Play or Apple App Store to download the app:
To locate the relevant information to put the marketing claim into context, a user would need to scroll down, expand a description by clicking “More” and scroll further to an easily missed section titled “LEGAL THINGS.”
The rare user who finds and reads these disclosures might take issue with the characterization of getting money “instantly”:
*To qualify for a Varo Advance your account must be at least 30 days old with a balance of $0.00 or greater, with qualifying direct deposits in the Varo Bank Account and/or Varo Savings Account of at least $1,000 over the past 31 days. Your Varo Bank Account and/or Savings Account must not be overdrawn, and your Varo Bank Account cannot be suspended or closed. For Advances over $20, Varo will review your payment history and qualifications monthly and may increase your credit limit. To continue to qualify for Advances, payments must be made timely.
Instead, a user who newly opens an account may be surprised to find they need to wait at least thirty days and have direct deposits totaling least $1,000 in that period in order to qualify for even $20 -- they may qualify for more at some unspecified, later time only upon meeting additional, ambiguous payment history and qualification requirements.
They would have to drill further, locating the program terms in this PDF, to learn that Varo assesses qualification for advances larger than $20 once monthly, prior to the start of each month.
Could this be “deceptive”? Applying the same three part assessment:
Is there an omission or misrepresentation? Yes.
That is likely to mislead consumers acting reasonably under the circumstances? Yes, a reasonable user is likely to conclude it is possible to obtain up to $100 “instantly” upon signing up for Varo.
This omission or practice is “material.” Yes, the difference between accessing up to $100 “instantly” vs. accessing $20 in 31 days is material.
As with Chime, it’s unclear what proportion of users who meet the stated requirements are approved for an advance and for what amount.
While Varo is currently waiving fees for its advances, it intends to begin charging moderate fees after March 31, 2021. While undoubtedly less expensive than a traditional overdraft or payday loan, this is still an expensive form of borrowing - something that may not be clear to consumers given the lack of traditional disclosures.
While not required to disclose cost as an APR, it’s worth nothing that a $100 advance with a $5 fee for 7 days is equivalent to a 260% APR; if the user repaid after 30 days, the APR would be a still hefty 60%.
Ads May Run Afoul of Facebook Policy
Chime and Varo’s advertising of their SpotMe and advance products, respectively, may violate Facebook advertising policies designed to protect users. Specifically, Facebook advertising policy prohibits:
“Payday Loans, Paycheck Advances, and Bail Bonds
Ads may not promote payday loans, paycheck advances, bail bonds, or any short-term loans intended to cover someone's expenses until their next payday. Short term loan refers to a loan of 90 days or less.”
While neither Chime nor Varo are advertising payday loans, both could be construed as “intended to cover expenses until [a user’s] next payday” and both are explicitly designed to be repaid in less than 90 days. Further, Varo is explicitly referred to in Facebook/Instagram ads as an “instant cash advance,” which would appear to be in direct violation of Facebook policy.
Would this really turn into an issue with Regulators?
With Rohit Chopra on track to take the helm at the CFPB, it’s safe to say supervision and enforcement will return to a more “CFPB Classic” mode, with the agency already taking steps to reverse Trump-era policies in order to strengthen supervision and enforcement. And previously Richard Cordray, the CFPB Director under Obama, made clear that startups / fintech wouldn’t get a free pass, stating in a consent decree:
“The CFPB supports innovation in the fintech space, but start-ups are just like established companies in that they must treat consumers fairly and comply with the law.”
Current Acting Director Dave Uejio has made the bureau’s priorities crystal clear: protecting consumers, particularly economically vulnerable ones - a designation which seems likely to include many users of Chime and Varo, particularly those using (or wanting to use) overdraft or advance products.
How a theoretical bureau supervisory or enforcement action unfolds would likely depend on the degree to which consumers experienced harm and the number of consumers impacted - something that is difficult to assess as an external observer.
Chime and Varo’s Responses
A draft of this report was shared with representatives for both Chime and Varo.
Varo responded by pointing out the recent joint regulatory guidance encouraging small-dollar lending. It further stated that Varo’s Advance product was reviewed with the OCC prior to launching it and that all terms and conditions are made available on its site.
Chime declined to comment.