In July, the Federal Bureau for Financial Consumer Protection (CFPB) canceled its well-balanced 2017 guarantees for payday loans and the like with terms of up to 45 days. This change will be a setback for the millions of borrowers who will not have these protections, but banks can help mitigate the damage.
Payday borrowers have checking accounts and income; payday lenders require both as a condition of the loans. Many borrowers are hungry for alternatives. About 8 in 10 payday loan borrowers say they would borrow from their bank instead of payday lenders if they were to offer small loans. Banks, however, have been mostly on the sidelines due to regulatory uncertainty.
But in May, the Office of the Comptroller of the Currency, the Federal Reserve Board of Governors, the Federal Deposit Insurance Corp. and the National Credit Union Administration for the first time issued joint guidance on their expectations for small dollar loans, mitigating much of this. uncertainty. This action is the culmination of years of research and consultation with industry and community stakeholders, as evidenced by previous statements and a formal request for information from the FDIC. As a result, banks are now well positioned to offer small, affordable loans to their customers who are currently using high cost credits such as payday loans and auto title loans.
Regulators have set guidelines for financial institutions, giving the green light to a simple and inexpensive loan origination process. This is a key development, as costly, time-consuming, or difficult requirements to offer loans as small as a few hundred dollars make these loans unprofitable and therefore make banks less likely to offer them.
Regulators have specifically adopted low-cost, automated methods to assess the repayment capacity of loan applicants, including the use of “internal and / or external data sources, such as deposit activity”. This means that banks could assess the creditworthiness of their own customers and issue loans without purchasing third-party information. This reduces the cost of originating loans for small installment loans or lines of credit and helps to allow for fair pricing for consumers.
The FDIC also rescinded a 2007 watch letter that encouraged banks to lend at unsustainable prices (no more than $ 24 for a three-month $ 400 loan, a price banks don’t lend because they tend to lose money). This is important because banks can profitably issue a three-month $ 400 loan for around $ 60, which is six times less than the average $ 360 charged by payday lenders.
Potential new banking offerings compared to single payment loans
Comparison by average cost and affordability
Potential new bank loans or lines of credit with small installments
Cost of borrowing $ 500 for 4 months
$ 90 to $ 100
Share of next paycheck due for loan
Source: Pew Charitable Trusts
Regulators have included several protections for borrowers in their guidelines, encouraging banks to only issue loans “that support borrower affordability and successful repayment of principal and interest / charges within a reasonable timeframe rather than re-borrowing” . The guidelines aim to encourage the creation of programs that have a “high percentage of clients successfully repaying their small dollar loans in accordance with original loan terms” and to discourage “debt cycles due to refinancing or re-borrowing” .
Banks are unlikely to meet these standards by offering single payment loans, such as deposit advances. Similar to payday loans, these advances often lead to repeat borrowing as they consume such a large chunk of a borrower’s next paycheck. However, these principles are easy to adhere to with installment loans and lines of credit, which have small, manageable payments that reduce the loan balance.
Additionally, in May, the CFPB released a so-called no-action letter template that provided additional legal protections for small loans issued by banks or credit unions. These letters set out the basic conditions under which financial products would not trigger regulatory problems. The Bank Policy Institute’s model no-action letter encourages banks to offer loans that are repayable for terms ranging from 45 days to one year. These protections generally do not extend to payday loans or deposit advances with a term of less than 45 days.
Like the Joint Guidelines, this model contemplates a simple “criteria-based underwriting that includes the borrower’s transaction activity in their accounts with the borrower. [bank]”- a process more commonly referred to as cash flow underwriting. The letter also applies to loans “linked to a borrower’s deposit account at [bank]Which means that the protections are only available for loans that banks and credit unions extend to their own customers. This is appropriate, because the loans that banks make to non-customers involve more risk and more expensive underwriting and are sometimes made through expensive, high-risk partnerships with payday lenders who ignore state laws.
Despite speculation that banks are unwilling to lend to their customers who use small loans, Pew has had over 100 conversations with executives of banks and credit unions about it and has found substantial interest in offering loans. in small installments. Moreover, people are saying overwhelmingly that they would view banks in a more positive light if they offered such loans, even though the annual percentage rates would be higher than those for credit cards. In surveys, the public (80%) and payday loan borrowers (86%) believe the prices banks say they have to charge for such loans are fair.
Small installment loans from banks would come in handy now that the CFPB has abandoned its consumer guarantees for short-term loans, as most non-bank loans in this market will remain extremely risky for consumers. Affordable bank credit options would create hundreds of dollars in savings each year for typical Americans who today use payday credit, title, lease purchase and other forms of non-bank credit expensive. Pew has published standards for these loans that allow banks to deliver them quickly and cost effectively while keeping them affordable for customer repayment.
Nick Bourke is a Director and Alex Horowitz is Senior Research Officer in The Pew Charitable Trusts Consumer Funding Project.