Opportunity or Minefield for Lenders?

Borrowers, especially millennials, love peer-to-peer payment apps. Apps such as PayPal, Venmo, Zelle, amongst others, eliminate the hassle of writing checks. With the proliferation of their use, private and institutional lenders are wondering if they should indulge their borrowers and start accepting payments from these apps?

The short answer is no — the risks outweigh the potential reward. Unlike merchants that readily accept these forms of payment, lenders have a unique duty to keep federal and state regulators happy. The vulnerability of peer-to-peer payments to scams has the potential to make you as the lender, as well as the regulators, very unhappy indeed.

Until recently, federal law only required a private lender or bank preparing to make a loan to search the title and records of the property. Lenders had a fiduciary duty to investigate the borrowers’ ability to repay, but as far as the regulators were concerned, they had no obligation to search the background of a borrower or the source of its payments.

After the 2008 foreclosure crisis, the Truth in Lending Act was amended, and many states enacted legislation to protect borrowers. These regulations not only imposed a new duty on lenders to verify the ability of borrowers to repay, they also created a duty to investigate suspicious transactions. If a lender fails to fulfill this duty, its bona fide interest in the property will not be protected. Lenders are now required to file suspicious activity reports (SARs) if money laundering or fraud is suspected, and these new payment apps have the potential to introduce new scams and money laundering risks into the equation.

First Came PayPal

In PayPal’s earliest days, fraud was its existential threat. Credit card chargebacks and money laundering were out of control, and entire accounts were stolen by phishing. To fix this, PayPal rolled out CAPTCHA technology, now widely used to block spammers from making fake accounts. It also built an algorithm to identify abnormal data patterns, and fraud rates dropped dramatically. Today 170 million people use PayPal, and the company’s fraud rate is only 0.32 percent of revenue, compared to an average of 1.32 percent for merchants, according to LexisNexis.

However, PayPal has built in consumer safeguards that can harm lenders accepting its payments. Money passes from sender to PayPal, which ages it a few days before depositing in the receiver’s account. A borrower can put into dispute any payment made to the lender over the past six months by claiming it was unauthorized. If the lender accepts PayPal from other borrowers, PayPal may unilaterally debit the lender’s account and withdraw the disputed amount. It’s a tactic used by scammers in merchandise sales, easily replicated by unsavory borrowers.

The Newest Entrants

PayPal launched Venmo, the mobile payment service adored by millennials. Funds transferred through this app don’t move directly from one bank account to another. Instead, they sit in Venmo’s “digital wallet”— not insured by the FDIC—and receivers manually transfer funds to their bank accounts, which can take 2-3 days.

Lenders considering the app should know that the FTC sued Venmo in 2016 for its failure to adequately disclose the fact that transfers between payer and receiver can be frozen. A borrower simply submits a dispute and adjudication is handled by Venmo, not in the jurisdiction of the loan agreement. The FTC and Venmo settled earlier this year, and Venmo claims they have significantly strengthened privacy and data security.  Regardless of these internal changes, the legal departments of most private and institutional lenders would surely get heartburn over the fact that Venmo calls the shots on disputes.

The newest entrant is Zelle, a person-to-person platform developed by over 30 banks. The service offers a standalone app and is integrated in the mobile apps of major participating banks, including Bank of America, Chase, Citi and Wells Fargo. Zelle reports it was used to transfer $75 million in 2017. Money moves directly from one bank account to another without stopping in a digital wallet. Unlike an ACH payment, which requires account numbers and 2-3 business days to clear, Zelle transfers funds in minutes.

This may be tempting to lenders. To initiate a transfer, a borrower simply enters the lender’s email, Zelle sends a message and the lender clicks a link to accept payment. But Zelle’s speed makes it a prime target for criminals. It does not have the safety features PayPal offers. Zelle offers no recourse other than suggesting that users only transfer money to people they personally know.

Borrower scams

While neither the OCC nor the U.S. Treasury has reported common scams using these apps with lenders, it’s a short hop to envision how check kiting and money laundering scams can be put on steroids if lenders were to start using them to facilitate payment to and from borrowers:

• A borrower sends a PayPal, Venmo or Zelle payment that is more than the monthly interest and principal, then asks the lender to wire them back the difference.
• The unscrupulous borrower paid the app with a stolen credit card, fraudulent bank account or overdraft.
• If the lender returns the “over payment” before discovering the fraud, the borrower clears out its bank account and disappears.
• PayPal, Venmo or Zelle claws back the borrower’s original payment in a reversal. Unlike with cash, check or wire transfer, they do not need a court order.
• If Zelle is used for the scam, there is no avenue for resolution short of suing Zelle. If PayPal or Venmo is used, at best the lender makes a case to PayPal’s legal department. At worst, it files a traverse motion in Santa Clara County, PayPal’s turf or writes it off.

When it comes to scammers, remember that digital payment apps can function as international person-to-person payment systems. Funds that cross jurisdictions create difficulties for authorities. U.S. law enforcement agencies have found that some digital payment platforms are ill equipped to verify customer identification, and some promote anonymous payments.

Considering a lender’s significant regulatory duty, and the amount of money at issue, the convenience of these services may be far outweighed by the potential for regulatory headaches and the loss of both principal and profit to a scam, with no recourse.