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Michael Calhoun is the president of the Center for Responsible Lending.
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Holdout Banks Cling to Debt-Trap Loans

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This week William Isaac, chairman of Fifth Third Bancorp (FITB), published a piece here defending payday loans and expressing concern about regulatory crackdowns on payday lending. This is not surprising given that—despite sharp regulatory warnings and widespread public opposition—Fifth Third may soon be one of only two banks in the nation that makes payday loans. Along with Regions (RF), Fifth Third appears to be attached to loans with triple-digit interest rates that mire people in debt. The banks insist on referring to these loans as "deposit advances," but they are designed to function just like other payday loans.

As Isaac notes, many American families are living paycheck to paycheck. He claims that this means they need access to short-term credit, and that payday lending meets this need. But he is wrong; these loans are not short-term at all. When cash-strapped borrowers take out a payday loan, their next paycheck may be enough to repay the lender, but it doesn’t leave enough to cover necessities, such as rent or food. Too often, the borrower must take out another loan and pay yet another fee, and the cycle of debt begins. Payday loans quickly turn into long-term, high cost, loans that borrowers cannot escape.

The debt trap nature of payday loans is not theoretical; study after study shows it is all too real. Recent research by the Consumer Financial Protection Bureau found that the median borrower took out 10 payday loans from a single storefront lender during one year, and spent 199 daysof the year in payday debt. These findings were generally consistent with other studies by the Center for Responsible Lending, my organization; the Pew Research Center; the Center for Financial Services Innovation; and reports by the largest payday lender in the country, Advance America.

To make this financial quicksand trap even worse, these loans typically are given in rapid succession, with the borrower paying excessive fees multiple times to continue to support the original extension of credit. And they lead to a cascade of bad financial consequences, such as increased likelihood of overdraft fees, delinquency on other bills, delaying medical care, and even increased likelihood of involuntary bank account closure and bankruptcy.

Particularly galling is that one in four bank payday borrowers are Social Security recipients. Borrowers on a fixed-income are especially at risk of getting mired in these loans.

Over the last decade, state and federal policymakers have taken numerous actions to curb payday lending. Today 22 states prohibit or significantly restrict payday loans. Congress determined that payday loans were a threat to military readiness, and banned lenders from making payday loans to members of the military or their families.

The banking regulators acted throughout the early 2000s to address safety and soundness concerns caused by banks partnering with storefront payday lenders to circumvent state laws. And in April this year, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. proposed guidance to address central problems with bank payday lending.

Unlike the OCC and FDIC, the Federal Reserve has not proposed explicit requirements for the banks it supervises. However, it recently issued a statement emphasizing the "significant consumer risks" posed by payday lending and concerns about banks making repeat loans to borrowers. Fifth Third is one of two banks supervised by the Federal Reserve that make payday loans; the other is Regions. By continuing to make these loans, Fifth Third and Regions are not only putting their own customers at risk, they also appear to be ignoring a warning from their own regulator.

Data about payday loans, whether made by banks or storefront lenders, point to patterns of long-term indebtedness and loan churning that undermine economic security. The bottom line is payday loans are a defective financial product, and the CFPB should issue rules that would put billions of dollars back in the pockets of families who could really use that cash.

Michael Calhoun is the president of the Center for Responsible Lending.

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First, I want to be clear that my comments about the importance of payday lending to millions of individuals were not, as Mr. Calhoun knows, in reference to any lending programs Fifth Third, Regions or other banks may have in place to help their customers meet financial emergencies, which do not constitute payday lending as that term is commonly understood.

I have long held the view that people like Mr. Calhoun (and regulators, for that matter) - however well-intentioned they might be - do not know and should not dictate what millions of people clearly need, as evidenced by their behavior in the marketplace each day. I first wrote on this subject in this newspaper nearly a decade ago. My view then and today is that the payday lending industry is clearly performing a very important function and should be embraced and regulated, not driven underground.

Payday lending is very simple to understand. And it is easy to compare the cost of a payday loan to the alternatives facing a borrower - losing a job for lack of transportation because a car needs repair, losing electricity, losing heat during the winter or air-conditioning during the summer, being assessed late fees on mortgage or credit card payments, losing telephone service, or incurring overdraft fees. Millions of intelligent people routinely make these calculations daily and decide to pay a relatively small fee for emergency funds rather than face much worse consequences. I don't believe Mr. Calhoun or regulators are smarter or wiser than these people.

Payday lending is not intended to be a permanent fix - it is clearly a quick fix in an emergency situation until the borrower can find a better solution, which might involve arranging a longer term loan, taking a second job, buying a new car, or selling some asset.

No one is forced to enter into a payday loan. Payday loans are unsecured and are always small loans. If a payday loan is not repaid, the lender has no meaningful recourse. It can't repossess a car, foreclose on a home, or even economically take a court action to collect. States regulate the number of rollovers of the loans, and no intelligent lender wants to roll over loans for very long as it inevitably results in larger write-offs.

Short-term emergency loans are clearly essential to millions of people, as is proven in the marketplace each day. Rather than banning these loans and driving them further underground, regulators ought to search for ways to bring them into the mainstream regulated financial system in order to keep unscrupulous operators from dominating the space, which they most certainly will do. I strongly prefer to see this type of lending carried out in federally insured and regulated financial institutions. Among other things, increased competition among reputable firms will improve pricing for borrowers.

The banking system should be encouraged to reach out to and meet the needs of borrowers from across the economic spectrum. I have seen no meaningful progress over the decade since my last article on this subject. We are way too focused on a futile and mistaken policy of trying to shut down the public's access to short-term emergency funds and not enough focused on how best to meet this obvious public need.

Bill Isaac, former Chairman, FDIC
Posted by billisaac | Friday, August 16 2013 at 7:30AM ET
Mr. Issac has resorted to the standard justifications of the payday loan industry, Those incidences that he has mentioned show a lack of reading the research hard data of why people borrow. Perhaps he would like to produce an in-house financial professional with a financial designation after their name such as CFP, RIA, etc. that will state in writing that payday borrowing at those interest rates and terms is good for their customers. I have asked top management at Wells Fargo, US Bank, and Regions Bank to do so and none of them have accepted the challenge.

Or perhaps he would like to refute my prior presentations on Bank Think that the after-tax Return on Equity of the deposit advance product exceeds 1000%. No one else at any of the deposit advance banks have taken issue with the numbers presented in these Bank Think columns. And I have given them many opportunities to do so. I have also engaged them (including the directors at US Bank and Wells Fargo) directly with the numbers and they have not refuted me.

If Fifth-Third really wanted to help their customers in need, there are many ways to do so that would earn them praise versus the vitriol and condemnation that are leading reasons why the banking industry reputation is at an all time lows as reported in the American Banker surveys released last month. Fifth-Third contributes to the generation of that ill will for the industry. And they especially are giving a poke in the eye to the citizens of Ohio who effectively eliminated the payday lending in the State of Ohio (HQ for Fifth-Third). Yes, now Fifth-Third, US Bank, and Wells Fargo have an oligopoly in Ohio and a perverse advantage as they avoid regulation by the Ohio State Banking department.

What say you Mr. Issac?
Posted by frankarauscher | Friday, August 16 2013 at 11:33AM ET
Mr. Rauscher's comments do not address the points made by Mr. Issac. People occasionally need small short term loans for one reason or another. The need is large and undeniable. The people doing business with payday lenders and taking out overdraft loans are not coerced to do that and most repay their loans. What are their options if not a payday lender or overdraft loan from a bank or credit union? I have asked this question to Mr. Rauscher before but he and other short term loan critics have not offered any practical alternatives. When the critics come up with better options this discussion will be worth having. Until then, it is not enough for people like Mr. Rauscher and Mr. Calhoun to merely say that don't like that kind of lending and make every effort to deny the option to those who need it.
Posted by gsutton | Friday, August 16 2013 at 1:42PM ET
When the banking industry had a "need to survive" in 2008, the lender of last resort was the US Taxpayer. Citizens did not say "This is our chance to abuse the banks with outrageous interest rates even though they have betrayed our trust"; instead, we provided needed relief through reasonably priced credit. We provided oversight to help the banks improve their position and we provided encouragement through the regulators for the banks to extricate themselves from their toxic positions. We did not create additional death spirals to increase toxic assets intentionally.

While the mechanics and details for a reasonable and acceptable program to assist needy customers in unforeseeable financial emergencies will vary by geography, demographics,economics, and each bank's software, there are some common aspects that I believe might be acceptable to many of those concerned with helping those in need.

1) The program should receive widespread support from the banking institutions own financial professionals who will collective sign-off that the program is good for their customer base. This would be a transparent action that they will be proud of.
2) The bank should define "predatory lending" for each of their consumer credit products including deposit advances.
3) The interest rate should be risk-based (as are most other consumer credits and the loss results should be public to validate the risk-based pricing) and easily calculated as an APR that can be compared with that of the rest of the market. Perhaps the cap should be 36% which would fit within the congressional approved rates for loans to the military (currently, every banker that I have asked to calculate the APR on a deposit advance loan cannot do it except for the product managers or staff that work with the product every day). I have found no one in branch offices that can do it. A rate of 36% would provide a return on equity superior to most consumer credit credit products at most banks; therefore, it survives a reasonable profitability test. Most banks are very happy with a Return on Average Equity when it hits 20%. There are almost 200 banks in the mid-tier range ($10-20 billion in size). Only three made a 3 year Average ROE above 20% (American Banker magazine - August 2013). Therefore, dropping the return from over 1000% to something in line with the actual risk seems reasonable in view of my opening comments.
When banks open checking accounts, they have the opportunity to perform an initial underwriting of the new customer and integrate it into credit update programs. There are too many opportunities to have a good understanding of the customer for them to be written in this post. Any competent retail banker (must have good credit background for this) can figure this out. therefore, some form of underwriting can be performed in advance of the actual need for a deposit advance. Many banks already do this on their overdraft limits.

Payback terms, credit reporting, and other aspects require more space than available here. they are very important to helping the customer return to financial stability (I assume that is one of our objectives - isn't it?)
Hopefully, this gives you something to digest. My point is that the industry needs help from a range of stakeholders. Letting the CFPB design a product is folly but this is what happens when there is no leadership.
Posted by frankarauscher | Friday, August 16 2013 at 3:41PM ET
The payday loan product is evolving as we "discuss" this issue. Underwriting costs for small dollar loans are falling as a result of big data/social media activity algorithm implementation and Internet channel velocity increases. New, medium term loan products, having an amortized component are being developed and offered to borrowers. Lender competition for borrowers has been on the increase. (This aspect has taken a negative "hit" in the short term as a result of all the "noise" this week.)

Seriously! The industry as a whole WELCOMES clearly defined rules and disclosure. Achieving this, lenders, critics, regulators and so-called consumer activists need do nothing more than get out of the way and allow entrepreneurs to serve the 60M consumers who want/need/demand access to these small dollar loan products.

Lenders having patience and strong compliance teams will benefit handsomely over the long haul. Consumers will benefit as well via lower rates and a broader spectrum of loan products to choose from. Banks with knowledgeable compliance officers and insight will profit as well by enabling all stakeholders to continue to participate.
Posted by Jer - Trihouse Consulting | Friday, August 16 2013 at 8:02PM ET
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