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Forget Payday, It's Time to Reinvent All Lending Practices

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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.

More continuity among all lenders would empower consumers to gradually establish themselves as responsible borrowers.  Banks, consumer lenders, startups and regulators should collaborate to innovate and improve access to credit with meaningful protections. One approach, for example, would involve the establishment of "neighborhood financial services centers" offering a mix of services – from deposits and secured loans to check-cashing services, micro-credit and other unsecured loans. 

Based on a real track record of successful and timely repayment – not a credit score – borrowers would migrate from higher-cost, nonprime lending to lower-cost options. Consumers would subsequently travel a reasonably predictable path toward a sustainable banked relationship and improve their credit histories, attaining significant long-term savings and upward mobility. 

The American economy relies on the working middle class as the engine for economic growth and stability.  When the current market for consumer credit fails the middle class, it fails Americans collectively. Revisiting, even reinventing, the way the financial services industry serves consumers, especially in challenging economic times, is a transformative step toward rebuilding the American middle class and producing a sustainable, affordable fiscal stimulus.

William M. Webster IV is former CEO and chairman of Advance America, a provider of payday loans and other consumer financial services.

 

 

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Comments (5)
Consumers should know by now you can't trust the banks, and you certainly can't trust the government to protect you from the banks. No matter what consumer advocates say otherwise, you don't need shoddy rules and shifty politicians to protect yourselves from debt. Budgeting, balancing your checkbook and paying paydayloans back on time are by far the most effective means of avoiding debt problems.
Posted by robertq | Tuesday, February 19 2013 at 7:58AM ET
RobertQ is right! Mr. Webster is wrong! At least Webster identifies himself as the former CEO of a payday lender which is offering loans in my state (Texas) at 533% to 664%! That really helps get one out of a financial bind!
At least non-bank payday lenders show the APR while one can argue that deceptive, abusive Wells Fargo, US Bank, and Regions Bank hide under a "loophole" that allows them to show the real APR! And they operate under another "loophole" wherein they are exempted from state banking laws - a real PERVERSE ADVANTAGE of a law that was to promote competition and not provide abuse and entrapment in a financial death spiral! These banks ignore the 36% interest rate cap on loans to the military because they have no care! They use "risk based pricing" on their other consumer credit but do not use it on loans to their neediest customers because they can take advantage of their financial illiteracy! However, it must make the bank CEO's smile when they get that annual bonus because they earned over 1000% ROE on this product because they always conveniently forget to mention that they can leverage their capital at 10:1 instead of a payday lender that may be closer to 1:1
Posted by frankarauscher | Tuesday, February 19 2013 at 4:18PM ET
Lending to people with bad credit will always be risky. Simplifying the terms of credit for lending of any kind will give consumers a better understanding of what they are getting themselves into. But relatively speaking, payday loans are already a rather straightforward form of credit. If someone has a problem understanding that a payday loan is an advance on their next payday, they're probably having problems with credit generally.
Posted by dinoshapiro | Tuesday, February 19 2013 at 7:45PM ET
Yes, lending to people with bad credit is risky for the lender but it can be a financial death sentence for the uneducated borrower with a lack of self-discipline. No one expects the financial community to be a "nanny state" while the tax payers appear to be willing to subsidize the result of abusive financial practices with welfare subsidies. More and more citizens of states are catching on to the fact that they are subsidizing the result and are passing laws to ban the practice. Yet four major banks have conned the OCC into believing that payday lending is good for the consumer while 7000 banks (including Chase and Citi) know that it is bad for the consumer and will not do it. The CFPB will provide a wake-up call to the evil 4 banks. .
Posted by frankarauscher | Wednesday, February 20 2013 at 9:55AM ET
Mr. Webster - thank you for your article. I was impressed by your comments and think along those same lines. Let's simplify our industry terms, dump APR%, lighten the load, and get competitive.
Posted by CAB Consulting | Friday, February 22 2013 at 7:16PM ET
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