The Department of Justice and the Federal Deposit Insurance Corp. are pressuring banks to cut ties to online lenders whom regulators suspect of shady business practices, as part of a broad crackdown on frauds in the payment system, according to five people briefed on their work.
Examiners from the FDIC have audited banks to determine whether they work with some online lenders, including those operated by Native American tribes, according to the people, who spoke on condition of anonymity because the communications with regulators are confidential. The Justice Department has issued subpoenas to banks and payment processors, leading them to stop doing business with some lenders, the people said.
Jer Ayler, president of Trihouse Inc., a Las Vegas-based payday-lending consultancy, said the pressure from regulators has driven away hedge funds and private equity firms that were mulling investments in the business.
“There has been sophisticated money looking at the online lending space in the last few months,” Ayler said in an interview. “Now they’re saying, ‘Whoa, wait a minute here.’”
The regulators’ leverage comes from the need for online lenders to use the automated clearing house system, or ACH, a structure used to move payments among bank accounts. Mark Pearce, director of FDIC’s division of depositor and consumer protection, called the banks the “gatekeepers” to the ACH system at a recent congressional hearing.
Justice is also focused on the banks’ role in potential fraud, which goes beyond online lending to include telemarketing scams, fraudulent health care deals and fake government grants, said two Justice Department officials. The consumer protection working group of the department’s Financial Fraud Enforcement Task Force is handling the work.
Online lenders themselves are often hard to contact, and can move operations easily, said the two officials, who requested anonymity because the investigation isn’t complete. Payment processors are similarly easy to dismantle and set up quickly.
Banks, by contrast, are a fixed, known group of companies and can be deterred by investigations and litigation more easily than the lenders, the officials said.
Robert Rosette, a Phoenix-based lawyer for online lenders run by Native American tribes, said his clients are examining possible legal action against banks to obtain access to the payments system.
“By succumbing to this pressure, the banks are now discriminating against tribal governments, and we are not going to stand for that,” Rosette said in an interview.
Rosette also said the action violated the government’s pledge to consult with Indian tribes on matters affecting them. President Barack Obama signed an executive order to that effect in November 2009, after courting Native American support during the 2008 election campaign.
Much online lending involves so-called payday loans that borrowers agree to repay the next time they’re paid. Storefront versions of the business use a post-dated check to secure the loan.
Online lenders typically obtain customers’ permission to directly debit bank accounts, so cutting off access to the system that allows repayment could effectively put them out of business.
Storefront lenders made $30.1 billion of the $48.7 billion in total payday loans made in 2012, with online lenders providing the rest, according to John Hecht, an analyst with investment advisory firm Stephens Inc. The industry’s revenues were about $9.3 billion, with storefronts earning slightly more than half of that.
The FDIC has audited bank relationships with online lenders, and has told bankers that working with them may pose “reputational risks” that could harm the banks’ safety and soundness, according to three of the people.
“Based on specific facts/issues, we may work collaboratively with other regulators and/or law enforcement, as appropriate,” FDIC spokesman Andrew Gray said in an e-mail.
Allison Price, a spokeswoman for the Department of Justice, declined to comment. Nacha, the industry group that oversees the payment system, said in an e-mailed statement that it welcomes “combined efforts to identify and address the worst abusers of the ACH and other payment systems.”
The FDIC gave regulatory guidance to banks it supervises in 2012 on processing payments, Gray said. It specifically told banks they needed to conduct due diligence and monitoring of “high risk” merchants, including payday lenders, Gray said.
Peter Barden, a spokesman for the Online Lenders Alliance, said that the group’s members are “operating legally under the law” in the jurisdictions where they are based.
For example, some lenders operate out of the state of Delaware, where such short-term loans are legal, and use the Internet to extend the loans in other states, where they may not be legal. Others are run by Native American tribal governments, who have sovereign immunity from state laws.
“What’s really troubling is that the regulators can intimidate banks into not processing transactions because they don’t like these industries,” Barden said in an interview. “The only ones who’ll be hurt are the consumers.”
Barry Brandon, executive director of the Native American Financial Services Association, said tribal lenders comply with “all applicable federal lending laws” and the pressure from the government is “an outrage.”
“This level of unwarranted scrutiny by the federal government is unprecedented,” Brandon said in an e-mail. “While the administration encourages Native Americans to pursue economic development on all fronts, regulators are acting with a borderline obsessive desire to regulate Native American e-commerce out of existence.”
Jamie Fulmer, senior vice president for public affairs at Advance America Cash Advance Centers Inc., said his industry -- brick-and-mortar payday lenders -- welcomes such moves. His company, which is owned by Mexico’s Grupo Elektra, obtains licenses in each state where it operates.
“We think it’s altogether responsible for regulators to crack down on unlicensed lenders,” Fulmer said in an interview.
The Consumer Financial Protection Bureau last year attempted to investigate a group of tribe-based lenders. They responded by challenging the agency’s authority, and the agency relented, at least temporarily.
Companies operated by the Chippewa-Cree tribe in Montana, the Tunica-Biloxi tribe of Louisiana and the Otoe-Missouria tribe in Oklahoma last year were sent civil investigative demands, a kind of subpoena, for business data, according to two people briefed on the investigation.
One tribe, the Chippewa-Cree, charged that the agency had no authority because its director, Richard Cordray, had not been confirmed to the post by the Senate. He was confirmed on July 16.
Native American lending has drawn much criticism from states because tribes enjoy sovereign immunity, the legal doctrine that restricts state interference in their affairs. Tribes argue that state consumer-protection laws, like interest rate caps, don’t apply to businesses owned by tribal governments, and they need only comply with federal law.
Nevertheless, Rosette said that the federal crackdown is catching them in its net on the presumption that there’s fraud involved, and it is slowing their business.
“Tribes are not breaking any laws,” Rosette said. “It’s a complete mischaracterizing to lump us in with other online lenders.”