Recently, American Banker asked, "Can the Payday Loan be Reinvented?" This question, while provocative, is incomplete. It's time to rethink and seriously tackle consumer lending more broadly. It's time to improve lending so that it actually benefits consumers and reflects recent evolutions in technology and the marketplace.
The financial challenges Americans currently face aren't likely to subside in the near-term, limiting consumers' ability to bolster the economy. The financial services market is doing little to help, as many lenders fail to provide reliable access to affordable credit for middle-class Americans. Under the current system, consumers are segregated based on the credit they can qualify for and the fees they are willing and able to pay – with little effort to diversify consumer credit options. No wonder then, that the Federal Deposit Insurance Corp. recently reported an increase in the number of unbanked and underbanked households, as millions of consumers depart the financial "mainstream" entirely or in part.
Consumers and the nation deserve better. Revisiting and reinventing the way banks, credit unions and consumer lenders operate – and collaborate – will offer choices, protections and a path to greater financial security, while compelling greater consumer spending and a revitalized American economy. But our regulations and consumer financial services industry must advance in three critical respects.
First, the standards of disclosure for credit products' fees and terms must be vastly simplified and uniformly applied. For consumers to qualify for and compare borrowing options, they must understand what they are getting. This should apply to all comparable credit products and services. As long as all lenders are treated the same, competition and transparency will drive costs to the lowest point and provide the greatest benefit to consumers.
For example, a number of online startups have recently entered the consumer lending space, offering services comparable to a payday loan or bank deposit advance. While these services bring fresh competition and welcome innovation to the largely unchanged consumer lending industry, the associated regulation remains uneven, particularly at a time when countless unregulated online lenders exploit unsuspecting consumers.
For instance, only licensed payday lenders are required to disclose their fee as both a dollar amount (typically $15 per $100 borrowed, according to the Community Financial Services Association of America, the trade group representing short-term lenders) and an annual percentage rate. All such loans, whether offered by a startup or by a bank in the form of an overdraft fee or deposit advance, should be held to the same disclosure requirements to allow for comparison of competing products.
Second, particularly within the context of shorter-term credit, the use of APR as a representation of the associated fees should be abandoned in favor of an accurate measure of "real-dollar cost." Consumers make their credit choices based on the actual cost, not on the provider. For shorter-term credit solutions, APR unfairly implies an inflated cost compared to other options, while also frequently excluding appreciation, maintenance and penalty fees. As banks have begun to offer advance products, they typically disclose fees only as a dollar amount, recognizing that APR is not an accurate or meaningful measure of the cost for short-term loans.
Finally, and perhaps the most difficult challenge, is "credit migration." Consumers have largely dismantled the wall between so-called "mainstream" and "alternative" financial services – banks and nonbanks – choosing services that make personal and economic sense. Yet our regulations still impose this debilitating and expensive bifurcation.