Revised Guidance on Third Party Payment Processors

The FDIC issued a “clarification” on July 28 to the effect that banks had gone overboard in their reaction to the FDIC’s expressed concerns about third party payment processors. The pressure the banks have been subjected to is related to “Operation Choke Point” where the Justice Department, with the assistance of the federal bank regulators, have attempted to block of the flow of funding to certain businesses such as payday lenders by attacking the ability of third party payment processors who deal with the targeted businesses to maintain deposit accounts  with commercial banks. The expressed regulatory reason for this was that banks were exposed to undue reputational risk by assisting such companies to stay in business. While the ability of some of the underlying companies to operate across state lines is currently being litigated by various parties across the US including local cities, the FTC and the New York Attorney General, the businesses for the most part conduct businesses where they are located.

Operation Choke Point has received a great deal of publicity, particularly since it seeks to cut off funding to businesses whose operations are not illegal. The rub being that regardless of what you believe the merits of payday lending to be, once an agency of the federal government decides to put the squeeze on one line of commercial business, what stops them from picking on other lines business. In other words, why do they get to pick and choose who the winners and losers might be and isn’t there some risk that politics can raise its ugly head in the process.

The FDIC and the OCC published Guidance in November of 2013 where they define Reputation Risk as:

Reputation risk is the risk arising from negative public opinion. Deposit advance products are receiving significant levels of negative news coverage and public scrutiny. This increased scrutiny includes reports of high fees and customers taking out multiple advances to cover prior advances and everyday expenses. Engaging in practices that are perceived to be unfair or detrimental to the customer can cause a bank to lose community support and business.

The FDIC has previously provided guidance to banks with lists of merchant categories (contained in a footnote) that have been associated with higher-risk activity including credit repair services, debt consolidation and forgiveness programs, online gambling related operations, government grant or will-writing kits, payday or subprime loans, pornography, online tobacco or firearms sales, pharmaceutical sales, sweepstakes, and magazine subscriptions. Many institutions took this to mean that they should not bank any of the listed businesses and have closed existing accounts for fear of criticism during their safety and soundness examination.

The FDIC is now seeking to clarify that they did not intend for institutions to suddenly drop all of these types of businesses and that they should continue to do business with third party processors on a prudent basis. To accomplish this, the FDIC is reissuing guidance (FIL-127-2008, Guidance on Payment Processor Relationships; FIL-3-2012, Payment Processor Relationships, Revised Guidance; and FIL-43-2013, FDIC Supervisory Approach to Payment Processing Relationships With Merchant Customers That Engage in Higher-Risk Activities) and an informational article, “Managing Risks in Third-Party Payment Processor Relationships,” Summer 2011, Supervisory Insights, to remove lists of examples of merchant categories.

While this may ameliorate some of the pressure that banks have felt not to open deposit accounts for the previously listed businesses, the reality is that both they and the examiners know who was on the list and it is unlikely that the indirect pressure will cease absent some sort of Congressional action which would prohibit the Justice Department or the federal banking regulators from attempting to put certain types of enterprises out of business. Banks should continue to carefully monitor relationships with third party payment processors who handle payments for any of the previously listed lines of business and should remain wary of any processors who seek to use the FDIC clarification as grounds for processing items for any line of business that poses reputational risk. It seems unlikely that the FDIC examiners will change their opinion about the risks imposed by handling items for such businesses.