Maryland's financial regulator is trying to stop illegal online payday loans by going after the banks that help make the loans possible.
"Without the payday lender's bank, the payday lender can't operate in my state," said Mark Kaufman, commissioner with the state's division of financial regulation.
These banks provide access to the network that allows online payday lenders to automatically withdraw loan payments from customers' accounts.
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The institutions are all outside Maryland and the reach of the state regulator, but Kaufman said his office has turned over the names of eight banks to federal regulators in recent months. These banks know or should know that they are helping process loans that are illegal in Maryland, Kaufman said.
Payday loans allow workers to borrow in advance against their paycheck for a fee that's often the equivalent of an interest rate of several hundred percent annually. Maryland is one of 15 states that effectively ban such loans by capping the interest rate that can be charged on small loans. The highest annual rate that can be charged in Maryland is 33 percent.
State regulators have shut down payday loan storefronts in Maryland, but online payday lenders remain able to make high-rate loans to any Marylander with a computer and a bank account.
"It's very difficult as a state regulator… to regulate a virtual business," Kaufman said. "I can't issue an enforcement action without an address."
That's why Maryland and other states with rate caps are examining the role that traditional banks play in these loans.
New York's financial regulator, for instance, recently sent letters to 117 banks, asking them what they are doing to stop illegal payday loans from entering that state. Without banks providing access to the Automated Clearing House network, online payday lenders would not be able to debit consumers' accounts, the regulator said.
"This is a new tack that states are taking," said Alex Horowitz, research manager for the Pew Charitable Trusts.
Federal regulators also have been warning banks about online payday loans. The Federal Deposit Insurance Corp. told banks last year to monitor their relationships with third-party payment processors that may be requesting withdrawals from customer accounts on behalf of payday lenders. Ultimately, the FDIC said, the banks could be held liable for any fraudulent activity.
Maryland's division of financial regulation has received about 250 consumer complaints about payday loans in each of the past two years, and a couple of hundred more about businesses collecting on these illegal loans, Kaufman said.
Consumers, in some cases, have signed up for a loan online, giving an unlicensed payday lender authorization to debit their account, Kaufman said. Once they realize the high cost of the loan, they sometimes have difficulty stopping the debits, he said.
A Pew study last year found that 3 percent of adult Marylanders have taken out a payday loan in the past five years, in some cases going to nearby Delaware, which permits the loans, or borrowing online.
"The prospect of fast cash is appealing to consumers who are facing that economic hardship," said Tom Feltner, director of financial services for the Consumer Federation of America. "And the way the loans are structured makes it difficult to repay."
The CFA found that some loan terms authorize a payday lender to access all accounts in the borrower's name to collect on the debt, he said.
Online payday loans typically involve two banks — the borrower's bank and the payday lender's institution.
Kaufman said borrowers' banks have been working with his office to address consumer complaints, closing accounts to stop withdrawals.
But these illegal loans wouldn't have been possible to make in the first place without the help of another bank debiting borrowers' accounts on behalf of the payday lender, Kaufman said.
"They are the entry point into the system," he said. "Without them, none of this works."
Kaufman said when his office uncovers the name of the payday lenders' institutions — little-known banks outside of Maryland — it has turned over the information to the appropriate federal regulator.
He declined to name the banks, citing continuing investigations, except one — Bay Cities Bank. In a consent order with the FDIC in May, the Florida bank agreed to stop originating automatic withdrawals on behalf of payment processors. Bay Cities did not return a call seeking comment.
The Pew's Horowitz said it has been complicated for states trying to enforce their laws against Internet payday loans. Online lenders claim they are exempt from state law because they are offshore, incorporated in another state or affiliated with an Indian tribe, he said.
Peter Barden, a spokesman for the Online Lenders Alliance that represents 130 members, said these lenders are not subject to state laws.
"We believe the companies who are operating on the Internet are abiding by federal law," he said.
Marylanders and residents in other states with rate caps are going "online to get short-term loans because it's convenient and easy, and they can't find that kind of financial product in their states," he said.
And if there's any problem with a bad payday lender, he said, consumers can always tell their bank to rescind the debit authorization, he said.
Kaufman said though banks increasingly have been willing to help consumers, many times the loans from bad payday lenders are sold to shady debt collectors that violate collection laws.
Kathleen Murphy, president and CEO of the Maryland Bankers Association, said banks are willing to work with regulators to address consumer complaints. But having an informed and educated consumer is also needed, she said.
"At the end of the day, it comes down to the consumer making smart financial choices," she said. "To decide they need an advance on their paycheck at an interest rate of 500 to 600 or 700 percent annually is not a smart financial decision."