Federal regulators give green light to small installment loans from banks

In July, the Federal Consumer Financial Protection Bureau (CFPB) canceled its 2017 well-rounded safeguards for payday and similar loans with terms up to 45 days. This change will be a setback for the millions of borrowers who will miss out on 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 borrowers say they would borrow from their bank rather than payday lenders if they offered small loans. Banks, however, have mostly been 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 have for the first time published joint orientation on their expectations for small loans, alleviating much of this uncertainty. This action is the culmination of years of research and consultation with industry and community stakeholders, as evidenced by prior statements and a FDIC information request. As a result, banks are now in a good position to offer small, affordable loans to their customers who currently use high-cost credits such as payday loans and auto title loans.

Regulators have established principles for financial institutions, giving the green light to a simple, low-cost loan origination process. This is a key development because the 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 buying third-party information. This reduces the cost of loan origination for small installment loans or lines of credit and helps enable 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The FDIC also rescinded a 2007 watch letter that encouraged banks to lend at unsustainable prices (no more than $24 for a $400 three-month loan, a price at which banks won’t lend because they have tendency to lose money). This matters because banks can profitably issue a three-month, $400 loan for around $60, which is six times less than the $360 average charged by payday lenders.

Potential New Banking Offers vs. Single Payment Loans

Comparison by average cost and affordability

payday loan

Deposit advance

Potential new bank loans or lines of credit with small installments

Cost to borrow $500 for 4 months

$600

$400

$90-$100

Share of next salary due for loan

36%

27%

5%

Source: Pew Charitable Trusts

Regulators have included several borrower protections in their guidelines, encouraging banks to only issue loans “that support borrower affordability and successful repayment of principal and interest/fees within a reasonable time frame rather than borrow again”. The guidelines are intended to encourage the creation of programs that have a “high percentage of clients successfully repaying their small dollar loans in accordance with the original loan terms” and to discourage “cycles of indebtedness due to renewals or reborrowing.”

Banks are unlikely to meet these standards by offering one-time payment loans, such as deposit advances. Similar to payday loans, these advances often result in repeat the loan because they eat up such a big chunk of a borrower’s next paycheck. By contrast, these principles are easy to follow with installment loans and lines of credit, which feature small, manageable payments that reduce the loan balance.

Additionally, in May, the CFPB released what is called a model no-action letter that offered additional legal protections for small loans issued by banks or credit unions. These letters set out the basic conditions under which the financial products would not trigger regulatory issues. the Bank Policy Institute No Action Letter Template encourages banks to offer loans repayable over terms of 45 days to one year. These protections generally do not extend to payday loans or deposit advances with terms of less than 45 days.

Like the joint guidelines, this model envisions simple underwriting “based on criteria including the borrower’s transaction activity in their accounts with the [bank]– a process more commonly referred to as cash flow underwriting. The letter also applies to loans “linked to a borrower’s deposit account with [bank]meaning the protections are only available for loans that banks and credit unions make 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 high-cost, high-risk partnerships with payday lenders who ignore state laws. .

Despite speculation that banks don’t want to lend to their customers using small loans, Pew has had more than 100 conversations with bank and credit union executives about this and found substantial interest in offering small installment loans. Additionally, people overwhelmingly say they would view banks more positively if they offered such loans, even though the annual percentage rates would be higher than credit card rates. In surveys, the public (80%) and payday loan borrowers (86%) consider the prices that banks say they have to charge for such loans to be fair.

Small installment loans from banks would help now that the CFPB has dropped its consumer guarantees for short-term loans, as most non-bank loans in this market will remain extremely risky for consumers. Affordable credit options from banks would create hundreds of dollars in savings per year for typical Americans who today use payday payment, title, lease-to-own, and other expensive forms of non-bank credit. Pew has released standards for these loans that allow banks to offer them quickly and cost-effectively while keeping them affordable for customers to repay.

Nick Bourke is Trustee and Alex Horowitz is Senior Research Officer of The Pew Charitable Trusts Consumer Credit Project.

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