Regulators Warn Bank About Refund Anticipation Loans

The Federal Deposit Insurance Corporation (FDIC) has notified Republic Bank & Trust of Kentucky that the bank's high cost refund anticipation loans (RALs) are "unsafe and unsound."

The FDIC's action follows a similar action by the Office of Comptroller of Currency, which issued a regulatory directive on Christmas Eve against HSBC (H&R Block's RAL partner bank) prohibiting that bank from making RALs.

The two actions underscore how the highly profitable loans have recently fallen out of favor. Regulators and consumer advocates routinely lambaste them as too expensive, saying they take too much of the consumer's refund in fees.

149% APR

For example, Republic Bank is charging $61.22 for a RAL of $1,500, which translates into an APR of 149%.  RALs target low-income taxpayers -- especially recipients of the Earned Income Tax Credit, a special tax break for working poor families.  In 2009, RALs skimmed over $600 million from the refunds of 7.2 million taxpayers, consumer advocates say.

Despite the high profit margins, RALs have begun to attract too much uncomfortable attention for banks. Several have recently gotten out of the business, ending their relationships with tax preparers who marketed the loans to their customers.  Republic announced the FDIC warning at the end of last week in a filing with the Securities and Exchange Commission.

Last nail in the coffin

"This may be the last nail in the coffin for RALs," said Adam Rust, Research Director for Community Reinvestment Association of North Carolina (CRANC). "If so, we will be glad to see the death of these high cost, high risk loans."

Chi Chi Wu, Staff Attorney for the National Consumer Law Center (NCLC), agrees that the day of the refund anticipation loan may be over. "The FDIC-regulated banks were the 'last man standing' in making RALs," Wu said. "Now the FDIC has signaled that it too is forcing these last few banks out of the RAL business."

Republic is the RAL lender for Jackson Hewitt and Liberty Tax Service, the second and third largest tax preparation chains in the country.

Expensive loans

"We are pleased that the bank regulators may have effectively put an end to loans that siphon off hundreds of millions in taxpayers' hard-earned money and federal benefits meant to lift hard-working Americans out of poverty," said Jean Ann Fox, Director of Financial Services for the Consumer Federation of America (CFA).

RALs are one to two week loans made by banks and offered by tax preparers, secured by the taxpayer's refund.  RALs can be expensive, despite the small amount of risk they entail for banks.

In April 2010, JPMorgan Chase voluntarily exited the RAL market, leaving only Republic and two other FDIC-regulated banks as the last RAL lenders.

In recent years, the Internal Revenue Service (IRS) has stressed the use of its free services to file tax returns electronically. It recommends taxpayers also use direct deposit, saying that will speed up the refund process, with payments arriving in bank accounts sometimes in as few as ten days.