Increasing Popularity of ‘Early Pay’ Products Raises Thorny Questions

'Earned Wage Access' programs offered by fintechs could serve the genuine needs of consumers who otherwise get mired in payday lending cycles and draining overdraft charges. They could be a model for banks and credit unions seeking better alternatives (and trying to compete with the likes of Chime). But can these leading edge ideas survive traditional regulatory boundaries?

Earned Wage Access — allowing people to access wages earned prior to their payday — is growing in popularity.

Proponents herald these products as a consumer-friendly fintech alternative to overdraft fees and payday loans — and users are generally enthusiastic.

A November 2020 survey for DailyPay found that about 14% of U.S. consumers are already using these services and an additional 24% are very interested in trying them. And Aite Group reports that the total value of wages accessed by employees through these services increased from $3.2 billion in 2018 to $9.5 billion in 2020. Earnin, a fintech that has been offering an EWA product since 2013, announced in late 2021 that it has provided over $10 billion of access to earnings in advance of payday.

Not everyone favors these programs. In congressional testimony the National Consumer Law Center said early wage access products “are a lower-cost form of payday loan — wage advances repaid on payday — and should be regulated as credit.” Several states have considered legislation requiring regulation of some types of EWA.

Regulators and consumer advocates have raised valid and understandable concerns, but the best EWA products provide great value to consumers in need of small amounts of short-term liquidity. Often the only available alternatives are payday loans or overdraft fees.

Overdraft fees cost consumers $12.4 billion in 2020, according to the FinHealth Spend Report 2021. Preventing this sort of product coming to market will simply drive some consumers with urgent short-term cash flow needs to payday and predatory lenders, who are profiting handsomely from those who can least afford it. This is a perverse outcome, and one that can and should be avoided.

Can Regulation Actually Support Innovation?

Better for a consumer to pay a few dollars for an early wage access product than to be dinged for a $35 overdraft fee, or even worse take out a predatory payday loan at exorbitant interest and risk getting caught in a debt trap.

Indeed, banks and credit unions looking for consumer-friendly alternatives to overdrafts may wish to consider whether EWA offers an attractive alternative.

A small but growing number of financial institutions now offer early access to payroll deposits of up to 48 hours, which is another fintech innovation popularized by neobanks such as Chime. However, few have adopted EWA thus far and ill-fitting regulation proves a barrier. A fit-for-purpose regulatory framework that encompasses these products would protect consumers, provide regulatory certainty to fintech providers, and help give banks and credit unions the confidence to innovate responsibly.

(Read More: Why Banks & Credit Unions Should Pounce on the ‘Payday Revolution’)

“Why do we need a new regulatory framework?” heavily regulated banks and credit unions may ask. The simple answer is that EWA products do not fit neatly into the existing regulatory scheme. For example, Truth-in-Lending Act disclosures were designed to provide a common frame of reference that can be applied to a wide variety of complex, longer-term credit products. When applied to a concept as intuitive to consumers as “I will charge you $3 to advance you $250 until you get paid in 10 days,” the disclosure is likely to cause more confusion than enlightenment.

Misleading Metrics:

If treated as loans, the small size and short term of Earned Wage Access products mean that even a modest fee can be enough to make APRs exceed usury thresholds in many states, making them illegal. A modest $1 fee on a one-week advance of $100 with no additional interest would have an APR over 50%.

Read More About Overdraft Issues:

How Fintechs Seek Workarounds — Even Lending for Tips

This has led many of the fintech pioneers in this space to look for ways not to have their products treated as loans. The most common idea is to make the product a non-recourse advance. This means that the firm does not have the ability to initiate collection against the customer nor to report performance to credit bureaus. In this model, the provider will require the consumer to authorize it to debit the payment from their bank account after the paycheck is deposited and will commonly use a service such as Plaid so it can identify when funds are available.

Other strategies, often used in combination with non-recourse advances, include:

  • Offering the product as part of a subscription plan, sometimes bundled with other products and services, so there is no marginal cost for an individual advance.
  • Offering the service at no cost, but giving the customer the option to leave a tip.
  • Selling the service to employers, who then make the advance available to employees as part of a benefits package

These strategies have been necessary for firms to be able to go to market nationwide without falling foul of consumer protection laws, but result in much of the industry falling outside the scope of existing regulation. Some state regulators, quite reasonably, have concerns that this sector should be subject to some form of consumer protection oversight. And increasing numbers in the industry have come to believe that co-ordinated, proportionate regulation will benefit responsible firms by increasing consumer confidence in regulated providers.

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A Framework to Fit a New Wrinkle on Consumer Finance

So where should we go from here to allow lenders to reach this product’s potential to help consumers with proportionate levels of regulatory oversight?

1. States should follow the excellent example set by the California Department of Protection and Innovation and work collaboratively with firms in the industry to find a path forward.

Rather than using enforcement or lawsuits, the California regulator negotiated memorandums of understanding with a number of EWA providers. These require the providers to make reports about their activities and associated matters such as customer complaints, which will allow the DFPI to take a data-driven approach to determining whether regulation is appropriate. The memorandums also commit the firms to follow best practices and give the regulator the right to conduct examinations.

2. States should coordinate their actions, perhaps using the Conference of State Bank Supervisors to help, and, in the longer term, working towards creation of model laws and regulations.

3. States should collectively consider whether there is a category of short-term loans that should be exempted from usury laws based on criteria that ensure this exception does not get abused. Criteria could include limits on:

  • The size of the loan
  • The duration of the loan
  • Maximum cost, including fees, contingent fees such as late payment charges, and interest. This maximum could either be a fixed amount, a percentage of the loan amount, or a hybrid. Firms adopting a tipping model could be required to ensure tips cannot exceed the maximum cost threshold.

4. The Consumer Financial Protection Bureau has a potential role to play, especially in encouraging applications to its Trial Disclosure Sandbox for responsible innovation in disclosures for EWA products, recognizing that standard truth in lending disclosures do not work well to explain these products to consumers.

This would build on the openness shown by CFPB in granting Payactiv, an employer-channel EWA provider, an Approval Order exempting its products from the Truth in Lending Act.

Industry participants should continue to cooperate with regulators and be open to proportionate, coordinated regulation. Such efforts help build the consumer trust necessary for continued success, while making less-scrupulous providers accountable for their actions.

Perhaps most importantly, industry participants should recognize that they will be collectively stronger if they work together. The Responsible Business Lending Coalition’s work to develop the Small Business Borrowers’ Bill of Rights a few years ago is an excellent example of how firms with different business models can put aside their differences to establish common principles and good practices.

The Bill of Rights has been highly influential in guiding regulatory initiatives related to small business lending. By emulating that effort, lenders offering earned wage access products can similarly promote a more coordinated approach among states by setting high standards and getting responsible firms to pledge to meet them. These standards would cover strong consumer finance practices such as consumer disclosure, straightforward pricing without hidden fees, and handling of consumer complaints.

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