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Adam Rust is the director of research at Reinvestment Partners, an advocacy group in Durham, N.C.
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Banks Must Stop Financing High-Cost Consumer Lenders

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Banks should not be using the benefit of low-cost capital made available to them by their status as regulated institutions to fund businesses that extend harmful high-cost lending products. Let hedge funds, venture capitalists, and other nonbank sources provide that capital.

Reinvestment Partners, my nonprofit advocacy group in North Carolina, is releasing a report Monday that documents $5.5 billion in loans made by banks to a variety of publicly-traded high-cost consumer finance companies. By following the money, our paper reveals the close relationship between some of our nation’s largest financial institutions and the fringe lenders that populate storefronts in neighborhoods across America.

Some would decry the idea of divestiture on the grounds that business and morality should not intersect. But from a social cost-benefit analysis, the costs inflicted upon working-class households in America far outweigh any of the financial benefits reaped by the lenders.

Leaders of consumer-facing companies make a mistake when they ignore any risk to their brand. This is one of the cases where business and morality do intersect. After all, it is not as if banks are making big profits by participating in this business. Right now, the average interest rate on debt extended to payday lenders and their brethren by some of the nation’s largest banks is only slightly more than 5%. On an after-tax basis, the spectrum of nonbanks identified in our paper fund their operations at a weighted average cost of capital of approximately 6.2%.

Significantly, consumers see no gains from the extension of so much corporate debt at these low rates. Some of the retail storefront payday lenders financed by these banks lend those dollars back out to the community at rates of as high as 500%.

This type of behavior is a net loss that outweighs many of the good things that banks do elsewhere in communities.

The relationships between banks and questionable operators do not end with corporate lending. Many high-cost nonbank lenders have individuals on their boards who currently or previously worked for large banks and investment houses.

High-cost consumer finance companies mentioned in our report make it explicitly clear that they need these loans. Consider a statement made recently by QC Holdings, a Kansas corporation whose subsidiaries offer payday loans, installment loans, and car title loans:

We depend on borrowings under our revolving credit facility to fund loans, capital expenditures, smaller acquisitions, cash dividends and other needs. If consumer banks decide not to lend money to companies in our industry or to us, our ability to borrow at competitive interest rates (or at all), our ability to operate our business and our cash availability would likely be adversely affected.

The shame of it all is that these banks could walk away from this line of business without any material impact to their profitability. The interest that would be foregone from divestiture would make little or no difference to a group of banks that together have trillions in assets on their balance sheets.

But if the banks do not want to divest, their regulator should make them do so.

The Office of the Comptroller of the Currency regulates nine of the ten largest banks lending in this space. The top five – Wells Fargo, Bank of America, JPMorgan Chase, Capital One, and Union Bank – all operate under the oversight of the OCC. The agency’s recent rulemaking on the deposit advance products marketed by several of its banks shows a concern regarding these high-cost products and the impact they make upon consumers of regulated institutions. But the OCC should also recognize that lending by national banks to these companies is a pressing problem. These practices pose a serious risk to the reputations of the banks under its supervision.

Adam Rust is the director of research at Reinvestment Partners, an advocacy group in Durham, N.C., and author of the blog BankTalk

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Comments (3)
One of several counter arguments to the notion expressed in this article is that further restrictions on access to financing increases the cost of funds to non-bank lenders, which manifests itself in higher charges to consumers.

Those genuinely interested in reducing the cost of small-dollar credit to consumers might be better advised to advocate for relaxing restrictions on banks dealing with non-bank lenders. The resulting competition for these relationships would exert downward pressure on rates which would allow non-bank lenders to reduce their charges to consumers without destroying their margins.

But the most important point to remember in this issue is that the non-bank, small-dollar credit industry exists and flourishes because banks refuse to make small loans to their depositors.

Before advising the OCC and other federal regulators to increase their ill-advised restrictions on bank lending to the non-bank businesses that serve the credit needs of consumers, self-styled advocates might consider pressuring regulators to improve their enforcement of the Community Reinvestment Act which mandates that banks serve the credit needs of communities where they source deposits.

What more blatant violation of the CRA could there be than banks that fail to serve the credit needs of their existing customers?
Posted by jim_wells | Monday, December 16 2013 at 4:53PM ET
What reputations do bankers have left to be at risk? Most of them have to hide or apologize for their banker already. I certainly do whenever I speak. The websites's "Banker of the Year" John Stumpf of Wells Fargo could not get even one public congratulations for the award! How low can you go?
The RISK is the realization by the public that these current banking leaders and their staffs may not have the technical competence to be leading these behemoths. They certainly do not provide transparency and generate confidence because they continue to engage in activities like the predatory lending which is the focus of this article!
Posted by frankarauscher | Monday, December 16 2013 at 5:34PM ET
Among the problems is the stringent regulations now in affect upon the community banking industry. The non-regulated lenders are not subject to the volume of unnecessary regulations which impact the ability of a community bank to make these loans. It is much easier to loan to the non-regulated lender with sufficient resources to cash flow their borrowings with the bank having to deal with just one entity. As a banker of over 60 years, I would love to be able to make these loans to qualified borrowers were it not for the garbage bag of regulations that encumbers the bank. Non-regulated lenders need to make a margin on their borrowings so that the cost of funds to their borrower is increased accordingly. Therefore, the consumer is paying an additional price for the overabundance of needless regulations. This is like a pyramid scheme by politicians and bureaucrats to create for themselves more power at the expense of every American---a sad commentary on the greatness of the past.
Posted by Alfred Kreps | Tuesday, December 17 2013 at 3:26PM ET
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