Refund anticipation loans: FDIC acted to protect banks, consumers and taxpayers

Consumer advocates are perplexed and disappointed as to why the FDIC inspector general is excoriating the FDIC for its entirely justifiable and appropriate actions over four years ago in encouraging banks to stop making high-cost, high-risk refund anticipation loans (RALs). These RALs were risky to consumers, banks, and the taxpaying public, and the FDIC acted after finding widespread legal violations by the tax preparers who acted as bank agents.

From the mid-1990s until 2012, a handful of banks (including three FDIC-supervised banks) made one- to two-week loans without underwriting for ability to pay; the loan was secured by the taxpayer’s refund. These RALs were extremely expensive: taxpayers paid fees from $30 to nearly $140, translating into APRs from 50 percent to 500 percent, in order to borrow their own money. From 2002 to 2012, RALs collectively skimmed over $9.6 billion from the refunds of tens of millions American taxpayers. 

{mosads}RALs targeted the most vulnerable, cash-strapped taxpayers. In 2010, over 90 percent of taxpayers who applied for a RAL were low-income, and nearly two-thirds (66 percent) were recipients of the Earned Income Tax Credit (EITC), the nation’s largest anti-poverty program. Tax credits intended to boost the earnings of hard-working low-income families instead paid for expensive loans that only lasted one to two weeks.

RALs also presented significant financial risks to consumers. If a refund was denied because of a preparer’s error or for any other reason, the taxpayer would end up on the hook for the loan, and could be subjected to debt collection harassment or a damaged credit rating.  They could even have next year’s refund – which families depend on – grabbed to pay off the loan.

But it wasn’t just consumers who were at risk from RALs. RALs present significant safety and soundness risks to banks because of the high levels of fraud and errors by many paid tax preparers. A startling fact about the tax preparation industry: in all but four states, paid tax preparers are not required to meet any minimum educational, competency, or training standard, which has allowed errors and fraud to flourish. Mystery shopper tests of tax preparers by the Government Accountability Office, the Treasury Inspector General for Tax Administration, and consumer groups have found levels of errors, fraud, and other abuses ranging from 25 percent to over 90 percent. Fraud has a direct impact on the safety and soundness of RALs because the accuracy of the tax return is critical in determining whether the loan should be made and whether it will be repaid.  

The role of the tax preparer is critical because they acted as the bank’s agent when making a RAL. Tax preparers solicited customers for the loans, explained (or failed to explain) the loan terms to consumers, processed loan documentation, obtained the consumer’s signature, retained the loan documents on file, and even printed RAL checks. Thus, the FDIC acted wisely when it decided to examine some of tax preparers that offered RALs. The FDIC found massive levels of legal violations, including noncompliance with the Truth-in-Lending Act, Gramm-Leach-Bliley Act, Federal Trade Commission Act and Equal Credit Opportunity Act. Nearly half (46.5 percent) of tax preparers examined were in violation of at least three different laws.  

The high levels of errors, fraud, and legal violations justified the FDIC’s actions in encouraging its supervisee banks to stop making RALs. Additionally, the FDIC’s actions were also based upon the IRS’s termination of the Debt Indicator, which helped tax preparers and banks make RALs by notifying them if the borrower’s refund would be intercepted by the government for certain debts. Without the Debt Indicator, a RAL could go unpaid, harming both the bank and the taxpayer. It was entirely appropriate for the FDIC to warn its banks of the safety and soundness risks of making RALs without the Debt Indicator. 

Finally, the FDIC was not alone in prompting its supervisee banks to leave the RAL market, as the Office of Comptroller of Currency had also forced two of its banks to stop making RALs. Both of these regulators acted wisely, appropriately, and were entirely justified in their actions. The FDIC should not be penalized for doing the right thing.

Wu is a staff attorney at the National Consumer Law Center with expertise in tax-time financial products, including refund anticipation loans.​