AL 2000-10
OCC Advisory Letter
Subject: Payday Lending
Date: November 27, 2000

TO:  Chief Executive Officers of All National Banks, Department and
     Division Heads, and All Examining Personnel


PURPOSE

The Office of the Comptroller of the Currency (OCC) is issuing this
advisory letter to ensure that any national bank that engages in
payday lending does so in a safe and sound manner and does not engage
in abusive practices that would increase the compliance, legal, and
reputation risks associated with payday lending and could harm the
bank's customers.

"Payday loans" (also known as "deferred deposit advances") are
small-dollar, short-term loans that borrowers promise to repay out of
their next paycheck or deposit of funds.  These loans typically have
high fees, are often renewed frequently, and, in the case of some
lenders or originators, may involve abusive lending practices, such
as the use of threats of criminal prosecution in loan collection.
OCC Advisory Letter 2000-7, issued July 25, 2000, alerted national
banks to the increased compliance, fair lending and credit risks
associated with abusive or predatory lending practices.

Although the OCC encourages banks to respond to customers' short-term
credit needs, payday lending can pose a variety of safety and
soundness, compliance, consumer protection, and other risks to banks.
In addition, some national banks have entered into arrangements with
third parties in which the national bank funds payday loans
originated through the third party.  In these arrangements, national
banks often rely on the third party to provide services that the bank
would normally provide itself.  These arrangements may also involve
the sale to the third party of the loans or the servicing rights to
the loans.  Such third-party arrangements significantly increase
risks to the bank and the OCC's supervisory concerns.  OCC Advisory
Letter 2000-9, issued August 29, 2000, described the risks associated
with engaging in certain credit-related activities with third
parties.  Payday lenders entering into such arrangements with
national banks should not assume that the benefits of a bank charter,
particularly with respect to the application of state and local law,
would be available to them.

The OCC will closely review the activities of national banks engaged
or proposing to engage in payday lending, through direct examination
of the bank, examination of any third party participating in the
transaction under an arrangement described above, and, where
applicable, review of any licensing proposals involving this
activity.  These examinations will focus not only on safety and
soundness risks, but also on compliance with applicable consumer
protection and fair lending laws.  In addition, the OCC may assess
special examination fees on banks to cover the OCC's additional costs
of conducting an examination or investigation of third parties that
provide payday lending services to the bank.  When the bank is not
following prudent lending practices or when examiners consider the
bank's lending practices to be abusive, the OCC will initiate
corrective measures, including enforcement actions when appropriate.


BACKGROUND

Payday lending is a type of short-term credit that is often used by
consumers with regular paychecks and bank accounts to meet unexpected
financial emergencies or other temporary cash flow needs, or as an
alternative to overdraft or credit card lines of credit.  These loans
are often priced at a fixed dollar fee, or a percentage of the loan
amount, which, when annualized, produces a very high annual
percentage rate (APR).  Because of financial circumstances and needs,
some borrowers are not deterred by the high APR that is disclosed;
nor, for the same reason, do they pursue alternative, less expensive
sources of credit.  While they are expensive as short-term credit,
payday loans that are renewed multiple times can be an exceedingly
expensive form of borrowing that may be unsuitable for some borrowers
over the long term.

As an example of a typical payday loan transaction, assume a consumer
needs to borrow $100 until his or her next payday.  The lender makes
the loan for a term of two weeks and charges a $15 fee.  As part of
the transaction, the lender will require the borrower to give it a
postdated check for $115 (or for $100, if the borrower pays the $15
fee in cash) to be held until the borrower's next payday.  When the
loan comes due, the borrower may repay the loan by allowing the check
to be cashed or by bringing in the full $115 in cash.  However, the
borrower may also "roll over" the loan by renewing the old loan (or
taking out another loan) and giving a new postdated check either for
$130 (the $115 balance due plus an additional $15 fee) or for $100
(if the fees have been paid in cash).  Because payday loans have such
short terms to maturity, the cost of borrowing, expressed as an APR,
is very high.  For example, the APR on a two-week $100 loan with a
$15 lender fee is 391 percent.

Some payday lenders have been criticized for such things as failure
to properly disclose the costs of the loan; failure to ascertain
whether the borrower is in a position to repay the loan in accordance
with its terms; unlimited and costly renewals of the initial loan
that perpetuate indebtedness; and the use of intimidation and
unwarranted threats of criminal prosecution in loan collection.

To address these potential abuses, some payday lenders have adopted
the following program features:

* Strict limitations on "rollovers"
* Strict limitations on the number of payday loans that any borrower
may have in a year
* Substantial waiting periods between loans 
* Right to rescind a loan without charge within 24 hours after it is
made
* Prohibition on fees to cash a check used to repay the loan 
* Clear and understandable disclosures concerning the costs and risks
associated with payday loans

In addition, some banks offer affordable substitutes for payday loans
by linking low-cost electronic accounts that have overdraft features
with direct deposit arrangements.  For example, under one program,
depositors with direct deposit arrangements may obtain overdraft
protection-with the overdraft to be repaid from the customer's next
electronic payroll deposit-at a cost substantially lower than that
typically offered by nonbank payday lenders.

Given our concerns about payday lending activities, this advisory
letter highlights the significant safety and soundness and other
risks associated with payday lending and provides guidelines for
addressing these risks.


RISK ANALYSIS

Payday lending programs, as offered by some lenders or originators,
may involve lending practices that are abusive.  In addition, payday
lending carries significant credit, transaction, reputation, and
compliance and legal risks that raise supervisory concerns. These
risks are discussed below:

Credit Risk

* Borrowers who obtain payday loans frequently have limited financial
capacity or blemished or insufficient credit histories that limit
their access to other forms of credit at a reasonable cost.  Payday
loans that are considered subprime loans are subject to specific
credit and other risks identified in the interagency and OCC
guidelines on subprime lending (see OCC Bulletins 99-10, issued March
5, 1999, and 99-15, issued April 5, 1999).

* Unlimited renewals, multiple renewals without principal reduction,
or renewals in which interest and fees are added to the principal
balance are not consistent with safe and sound banking principles.
Payday loans that remain on the bank's books are subject to the
Uniform Retail Credit Classification and Account Management Policy,
which establishes parameters for renewing credits.  Under the policy,
a bank must adopt explicit standards that control the use of
renewals, and the standards must be based on the borrower's
willingness and ability to repay the loan.  Payday lending that is
not subject to appropriate limitations on the number and frequency of
renewals would not meet the intent and standards of the policy.

* Contractual agreements with third parties that originate, purchase,
or service payday loans may increase the bank's credit risk due to
the third party's inability or unwillingness to meet the terms of the
contract.  As noted in OCC Advisory Letter 2000-9, the risks from
such third party arrangement "can be excessive if management and
directors do not exercise appropriate due diligence prior to entering
the third pary arrangement, and effective oversight and controls
afterwards."  Furthermore, a bank needs to have contingency plans in
place if a third party servicing the loans were to fail.  The risk
from the third party's failure to meet the terms of the contract also
results in increased compliance, reputation, and legal risk.


Transaction Risk

* Payday loans are a form of specialized lending not typically found
in national banks, but are frequently originated by unregulated
nonbank firms.  Payday loans can be subject to high levels of
transaction risk given the large volume of loans, the handling of
documents, and the movement of loans and funds between the national
bank and any third-party originators.  Because payday loans may be
underwritten off-site, there is the risk that agents or employees may
misrepresent information about the loans or increase credit risk by
failing to adhere to established underwriting guidelines.

Reputation Risk

* Due to the high fees and other characteristics associated with some
payday lending programs, many believe payday lending to involve
abusive lending practices, such as the use of threats of criminal
prosecution in loan collection.  Engaging in these practices could
increase the reputation risk for a national bank and cause it to lose
community support and business.  In addition, banks face increased
reputation risk when they enter into arrangements with third parties
to offer payday loans with fees, interest rates, or other terms that
could not be offered by the third party directly.

Compliance and Legal Risks

Banks that originate or purchase payday loans must take special care
to avoid violating fair lending and consumer protection laws and
regulations.  Failure to comply with statutory and regulatory
requirements may lead to various administrative actions, including
enforcement actions to address violations and to ensure appropriate
corrective action; lawsuits; and civil penalties.  For example:

* Equal Credit Opportunity Act (ECOA): High fees associated with
payday loans, combined with possible compensation incentives, may
foster abusive pricing or discriminatory steering of borrowers to
high cost payday loans.  In addition to ensuring nondiscriminatory
lending, the bank, as creditor, is responsible for complying with the
Regulation B requirements concerning notifying an applicant of action
taken on a loan application and providing the reasons for adverse
action.  Further, if credit-scoring systems are used to evaluate
borrowers' applications for payday lending products, a bank must
ensure that such systems comply with applicable Regulation B
requirements for system revalidation, and, if overrides are allowed,
that they are based on nondiscriminatory factors.

* Truth in Lending Act (TILA): A bank that is engaged in payday
lending must ensure that accurate TILA disclosures are provided to
customers.  If the bank provides payday loans through a third-party
arrangement, the bank, as creditor, is responsible for accurate and
timely TILA disclosures.  A bank that fails to disclose finance
charges and APRs accurately-taking into account the small dollar
tolerance for inaccuracies-risks having to pay restitution to
consumers, which, in some instances, may be significant.  A bank
would also violate TILA by advertising terms that are not actually
available.

* Fair Credit Reporting Act: A bank engaged directly or indirectly in
payday lending is responsible for complying with requirements to
provide adverse action notices to consumers when it declines an
application for credit based on certain information.  In addition, if
adverse action is taken based on information received from a third
party that is not a consumer reporting agency, the adverse action
notice must direct the consumer to the bank, and not any third party,
for details regarding the character of the information (even where
the payday loan applications are received by the bank through a third
party).

* Fair Debt Collection Practices Act (FDCPA) and Federal Trade
Commission Act (FTC Act): If a bank engages in payday lending through
an arrangement with a third party, and the third party regularly
collects defaulted debts on behalf of the bank, the third party would
be subject to the provisions of the FDCPA.  Although the bank itself
may not be subject to the FDCPA, it nevertheless faces significant
reputation risk-and potential legal risk for approving or assisting
in an unfair or deceptive trade practice in violation of the FTC
Act-if the third party violates the FDCPA and engages in deception,
harassment, or threats in the collection of the bank's loans.

* Lending Limits: In cases where a bank purchases payday loans from a
third party, such as a broker or joint venture partner, who continues
to service the loans, the aggregate of such loans may be subject to
the lending limitations of 12 CFR Part 32.

* Electronic Fund Transfer Act and Truth in Savings Act: A bank may
establish a payday lending program in which it opens a deposit
account for each payday loan customer, deposits the loan proceeds
into the account, and issues an access device to debit funds from the
account.  The disclosure and other requirements of both the
Electronic Fund Transfer Act and the Truth in Savings Act will apply
to such programs.


BANK SERVICE COMPANY ACT AND OTHER SUPERVISORY CONCERNS

In some situations, an independent agent, such as a check cashing
company, acting on behalf of the bank, may provide services in
connection with originating and collecting payday loans.  The
independent agent may operate under an agreement with the depository
institution to originate or facilitate extensions of credit in the
form of payday loans or similar short-term loans.

The OCC will closely review any payday lending activities conducted
directly by national banks, as well as any payday lending or
financing activities conducted through arrangements with third
parties.  The OCC will treat arrangements in which third parties
provide services in connection with the origination, servicing, and
collection of payday loans made by national banks as subject to the
provisions of the Bank Service Company Act, 12 USC 1867(c).
Therefore, the OCC may examine the performance of these services by
the third party to the same extent as if the bank itself were
performing these services on its own premises.  Such examinations
would evaluate safety and soundness risks, compliance with applicable
consumer protection and fair lending laws, and whether the third
party engages in unfair or deceptive acts or practices in violation
of federal or applicable state law.  In addition, the OCC will pursue
appropriate corrective measures, including enforcement actions, to
address violations of law and regulations or unsafe or unsound
banking practices by the national bank or the third party.

Concurrently with the issuance of this advisory letter, the OCC is
publishing in the Federal Register a proposal to amend its regulation
on assessment of fees (12 CFR Part 8) to clarify that the OCC may
assess a national bank a special examination or investigation fee
when the OCC examines or investigates the activities of a third-party
service provider.  The OCC will conduct such special examinations or
investigations if the activities conducted by the service provider
for the bank present heightened risks or are of an unusual or novel
nature, or when the bank has insufficient systems, controls, or
personnel to adequately monitor, measure, and control the risks
associated with the activity.  Due to the significant level of risks
to the bank posed by certain payday lending programs, the OCC may
assess national banks for conducting special examinations or
investigations of third-party payday loan service providers.


LICENSING CONSIDERATIONS

The OCC will scrutinize carefully any proposals submitted by national
banks or organizers that intend to originate payday loans, whether in
a new charter, through investments in third parties, or through
subsidiaries.  The OCC will require an application to be submitted
for any proposed investment in a company engaged in payday lending.
If a national bank proposes to enter into an arrangement with a third
party in connection with payday lending that will involve the bank's
subsidiary, the OCC deems that arrangement to be a new activity by
the subsidiary for which an application is required.  The activity is
not eligible for an after-the-fact notice.  In its review of, and
decision on, any such application, the OCC will take into account the
significant risks associated with payday lending activities and
arrangements with third parties described in this letter.  The OCC
will also take into consideration how the bank will address and
otherwise mitigate these risks consistent with the following
guidelines.


GUIDELINES FOR ADDRESSING SAFETY AND SOUNDNESS, REPUTATION,
COMPLIANCE AND LEGAL RISKS ASSOCIATED WITH PAYDAY LENDING

Banks must follow sound lending practices, manage their lending
risks, and be mindful of the burden the loan will place on their
customers.  Banks should ensure that they adhere to the following
criteria designed to minimize safety and soundness, reputation,
compliance and legal risks associated with payday lending:

* A bank should follow the Interagency Guidelines on Subprime
Lending, the Interagency Uniform Retail Credit Classification and
Account Management Policy, and OCC Advisory Letters 2000-9
(addressing third-party risk) and 2000-7 (addressing abusive lending
practices).

* A bank should establish policies and procedures to identify,
routinely monitor and control the credit, transaction, reputation,
compliance and legal risks associated with the bank's payday loan
programs.  Any payday lending policies and procedures should also
address applicable consumer protection and fair lending laws and
regulations.  Lending officers and any third parties acting on behalf
of the bank should be trained in the specific compliance policies and
procedures and risks concerning the payday loan product.

* If payday lending is done indirectly through a third party, the
agreement between the bank and a third party must establish adequate
controls over the loan transactions, and should clearly delineate the
services to be provided by the third party, including compliance with
the bank's underwriting and servicing standards, funding procedures,
reporting requirements, compensation, and other terms.

* A bank should monitor the collection activities, including
collection calls, of any third party on behalf of the bank.

* A bank should conduct on-site transaction testing and other audits
of third party vendors with whom it has arrangements to offer payday
loans for compliance with consumer protection laws and these risk
guidelines.

* A bank should develop a process to monitor, analyze, and ensure
appropriate resolution of consumer complaints concerning payday
loans, whether received at the bank or by a third party participating
in the transaction.

* A bank's board of directors should be provided periodic reports,
including compliance reports and audit reports, on the bank's payday
lending activities.

* Because of the credit and other risk characteristics of payday
loans, a bank also should limit its concentration risk by not
investing an undue percentage of its capital in payday loans it
originates or retains on its books.

* As with all lending, a bank should not make a payday loan without a
reasonable assurance that the loan will be repaid at maturity.  At a
minimum, such assurance must entail analysis of information about the
borrower's continued employment or other recurrent source of income,
or the borrower's reasonable expectation that additional income or
other deposit will be received on a date certain and that such income
or deposit will retire the loan.

* A bank should ensure that no more than one payday loan is
outstanding with the bank at a time to any one borrower.

* As a matter of observing "best practices," a bank should consider
offering each payday loan borrower a one-business-day cancellation
period during which he or she may return with good, collected funds
(cash, cashier's check, acceptable money order, or money transfer) to
repay the loan and receive a full refund of the fee.

* A bank should ensure that a third-party vendor with whom it has an
arrangement to offer payday loans does not impose a check-cashing fee
for the check written as part of the payday loan origination process.

* A bank should not renew a payday loan except upon a written request
by the borrower that certifies an inability to repay the loan, states
a specific reason that occurred subsequent to the date of origination
or last renewal, and states why the borrower will be able to repay
the loan at the new maturity date.  Multiple renewals-particularly
renewals without a reduction in the principal balance, and renewals
in which interest and fees are added to the principal balance, are an
indication that a loan has been made without a reasonable expectation
of repayment at maturity.

* A bank should provide each payday loan borrower a disclosure
statement that complies with TILA and other applicable disclosure
laws.  In addition, a bank should provide each payday loan borrower
with written disclosures, before such loan is made, that inform the
borrower

* of all loan terms and fees (including any applicable ATM fees)
associated with the loan;
* of the risks and potential problems of short-term borrowings and
the consequences of abuse;
* that alternativeforms of short-term credit exist that might be less
expensive and more suitable and advantageous to the borrower; and
* of the full cost of a hypothetical transaction that involves
multiple renewals in accordance with these criteria, and the possible
consequences of allowing the check to bounce, including the
imposition of fees for insufficient funds from the borrower's own
bank and the payday lender, and the loss of checking account
privileges, if applicable.

Such disclosures should be reasonably understandable and designed to
call attention to the nature and significance of the information.

Because of the significant risks involved, national banks should
consult their supervisory office before committing to any
arrangements described in this advisory letter or engaging in payday
lending activities.  Questions concerning this advisory letter may be
directed to the Community and Consumer Law Division at (202)
874-5750, or the Credit Risk Division at (202) 874-5170.

_____________________________			______________________________
Julie L. Williams                       Emory W. Rushton
First Senior Deputy Comptroller and     Senior Deputy Comptroller
Chief Counsel                           Bank Supervision Policy