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Banks Can Develop a Better, Cheaper Payday Loan: Date

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Raj Date, the former deputy director of the Consumer Financial Protection Bureau, wants to help banks build a better payday loan.

Date, who left the CFPB in January, on Thursday officially opened the doors of his consumer finance consulting firm, Fenway Summer. The company's first priority is mortgages, but Date said in an interview Thursday that he also wants to focus next on the thorny and politically charged arena of short-term credit.

Developing a better short-term loan is "the single most promising thing" in the portion of the consumer financial industry that serves low-income and other financially underserved customers, Date said.

"It's a real thing, and it's a real need, and it is pretty inefficiently provided today," he says, adding that he wants to work with "one or more" banks to help them develop a better version of their so-called deposit advance short-term loans.

Date was speaking on the sidelines of the Underbanked Financial Services Forum, an annual conference devoted to banking and technology for low-income, young, immigrants or other financially underserved people. (The conference is co-sponsored by American Banker and the nonprofit Center for Financial Services Innovation.)

He is picking a difficult — but potentially opportune — time to focus on short-term credit products as banks try to figure out how to best serve cash-strapped customers without angering consumer groups and running afoul of regulators. Regulators have introduced strict guidelines that some expect to essentially kill deposit advances made by such banks as Wells Fargo (WFC), U.S. Bancorp (USB), Fifth Third (FITB) and Regions Financial (RF). The CFPB is also formulating guidelines on short-term credit that would apply to both banks and payday lenders.

Consumer advocates have long criticized the pricing and structure of payday loans and their slightly cheaper bank-provided alternatives. Both are largely marketed to poor people, who pay a premium for unsecured loans that usually must be repaid in a couple of weeks. At the end of the term, many borrowers cannot repay the full amount and take out another loan to bridge the gap, thus getting deeper into debt and a repeat dependency on expensive credit.

Date sees what he calls "the small-dollar credit problem" as one that can be largely solved by better data, which can then give lenders an incentive to lower their prices. Banks, with their sophisticated and established operating systems, have the means to offer cheaper short-term loans and still make a profit — but they have to be willing to significantly rethink the prices they charge, he says.

"The credit costs are much higher than what they need to be. I think that through the application of more and different data sources, you can actually make fraud and credit decisions much better than has been possible in the past, and that, with the right competitive dynamic, can therefore start bringing pricing in," he says. "The deposit advance product should, just logically, have superior marketing costs — you already have the customer; superior credit costs — you control the account, fundamentally the fraud costs are much lower; superior operating costs — you are not building a new back-office system; vastly superior cost of equity, vastly superior cost of debt. So there is nothing about the product that isn't cheaper than the alternatives, overdraft and traditional payday."

Those two products have had too much influence on how banks determine what to charge for their deposit advances, Date adds: "Is this therefore a product that's expensive because it has to be, like traditional payday? Traditional payday I don't think can get much cheaper, because there's not enough margin in it. Or is it a product that is expensive because it can be? Because overdraft sets a price umbrella, and traditional payday sets a price umbrella," so banks say, " 'Whatever, just a little bit lower than that.' But that doesn't mean that pricing won't come in if there's competition."

He points to how prepaid cards were once much more expensive — until Wal-Mart (WMT) drastically lowered the prices on its version. "I would like to think that the same dynamic is possible in small-dollar credit. I would love it if that were the case. I don't know that it is, but it's definitely worth doing the work."

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Comments (5)
Mr. Date is correct. Currently the ROE for bank payday loans (deposit advance) is over 1000% after income taxes, losses, operating costs, and cost of money. I have provided this info to three of the four involved banks and none has been able to take issue with me. So banks are making outlandish returns off the backs of their own poorest customers. Mr. Date can do all the product design that he wants; but, there is no cure for a lack of sincerity to help the customers by the CEO's of those banks. The product design starts with some ethical acknowledgement that whatever is the true APR, that it will be disclosed and that the bank's own financial professionals will state in writing that the total cost of credit will be contained in that APR without any deception and that the rate is appropriate for the financial well being of their customer.

The other elements of the product design are easily done for the deposit advance customers. Those non-customers that are un-banked or are using traditional payday lenders will require coordinated support with other elements of the community as well as the banks. Many of these efforts exist and simply need bank leadership to implement.
I wish Mr. Date much success. The hardest part will be the reluctant CEO's of the four major institutions because no intelligent person would TRUST them; so maybe other banks can be the innovators and lead the way.
Posted by frankarauscher | Monday, June 10 2013 at 11:50AM ET
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Posted by Brainguru | Tuesday, June 11 2013 at 3:02AM ET
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Posted by roserofinda | Tuesday, June 11 2013 at 4:07AM ET
Short-term credit products, a type of alternative financial product, are tricky to work with. Nearly 15% of banked consumers had used them in the recent CFPB study. Many in the underbanked population clearly rely on short-term loans in order to deal with unexpected expenses. As Date pointed out, part of the issue with the high prices on these loans is that banks do not have the complete or accurate data on these consumers that they really need; especially banks still running a legacy system. This lack of data increases risk, and requires banks to charge higher rates.

The key to banks providing a viable consumer solution is the use of alternative data. That would allow statistical consideration of most underbanked consumers, even if they don't have a traditional credit score. Credit issuers would have the certainty to offer lower priced services to this population with less risk.

Unfortunately, it seems that many regulators are more inspired than ever to eliminate lending options for the underbanked. We may never get a chance to see what Date's innovative ideas might lead to.
Posted by Eric Lindeen | Monday, June 17 2013 at 4:41PM ET
Short-term deposit advance loans are not complicated and are easily doable if you have good credit administrators that really want to help their existing customers and not rip them off with returns on equity of over 1000%. If you read the CFPB data closely you will read that the 15% of customers is on a base of eligible customers which are about half of their depositors (remember - to be eligible, the customers needed a direct deposit relationship). Wells Fargo could blind us with brilliance or baffle us with baloney. Which do you think that they are doing?

Build the product backwards - Cost of money - instead of the current 30 basis points, use 500 basis points. Losses at 25%. Operating costs of 3% which is 50% more than their credit cards. At a 36% interest rate, it still provides an after tax ROA of 4% and Return on Equity of 36-40%. Not bad. Better than credit cards. But they want 1000%. Any credit people at Wells Fargo care to comment otherwise?

The reality is that this is a high-touch market (more people will need someone to actually talk to them) and Wells Fargo appears to only want to serve it with high-tech and reserve the high-touch for wealthy people. I hope that the OCC's CRA examiners have figured this out.

We already know that Wells Fargo directors are not smart enough to figure out that this product is a debt trap (I have it in writing from them that it is good and serves as part of their relationship banking) and the CFPB and OCC have confirmed that it is a debt trap. So who do you trust? Bottom line - a better cheaper payday loan is doable!
Posted by frankarauscher | Monday, June 17 2013 at 5:32PM ET
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