Banks are about to face a formidable new competitor in consumer lending. This powerful competitor boasts low rates, rock-bottom costs, terrific name recognition, a national distribution system, and an unbeatable relationship with the customer.

Surprisingly, this new force in lending is called the 401(k) plan.

The enormous latent potential of 401(k) lending is overlooked by both financial service executives and members of the general public. In my experience, only 5% to 10% of participants actually borrow from their accounts - but this will soon change. The sleeping giant of 401(k) consumer credit is about to awaken.

Most 401(k) plans are designed and marketed as retirement programs, with stringent "hardship" provisions that limit pre-retirement withdrawal. But the law is clear: Participants in a 401(k) plan can borrow from their account for any reason.

Until now, there have been two barriers holding back usage of this borrowing power. One is psychological - the perception among the public that a 401(k) is untouchable and sacrosanct, to be devoted solely to retirement. This is reminiscent of early attitudes toward credit cards - that they were to be used only for exceptional situations, and not for everyday household shopping.

The second barrier was that the amount of money in these accounts was relatively small. However, as 401(k)s gain in both popularity and market penetration, the typical account is approaching $40,000. This means that big-ticket purchases such as automobiles, personal computers, appliances, and even down payments on a home are within range of a 401(k) participant.

Moreover, as the average American becomes more accustomed to handling his or her own financial affairs, the simplicity, privacy, and empowerment of borrowing from one's own assets gains in appeal.

It's important to understand the provisions that regulate 401(k) borrowing. Among the major features:

*Participants can borrow 50% of their account balance, up to a maximum loan of $50,000. There is no minimum loan amount.

*If the account balance is under $10,000, participants can borrow all of the money, but must provide collateral to the extent that their loan exceeds 50% of their account balance. For example, a participant with an $8,000 account balance can borrow all $8,000, but $4,000 of the loan must be collateralized with a house, car, or savings account.

*The interest rate is determined at the loan's outset and is generally about two percentage points higher than prime. The term of the loan can be a maximum of five years and must be fully amortized with payments at least quarterly. The loan is repaid through automatic deductions from the borrower's paycheck - another attractive feature. Should the borrower terminate employment, he or she has the option of paying back the loan in full - possibly by borrowing conventionally - or taking the unpaid loan balance as a taxable portion of their 401(k) distribution.

Inevitably, 401(k) participants will soon grasp the compelling arithmetic of this credit channel. They will ask themselves, why go through the hassle, intrusive paperwork, and high interest of borrowing from a bank, automobile finance company, finance company, or credit card, when I can borrow from myself at a competitive interest rate and run no risk being rejected?

Why, indeed? The only major drawback to this approach is the opportunity cost. If the participant borrows from an investment that is returning 12% annually, and the participant pays only 8% on the loan, he or she misses out a net 4% return on the outstanding amount of the loan. However, this opportunity cost is unlikely to deter consumers who want a no-hassle loan in order to buy a first home or a new car.

Banks that help employers design 401(k) plans don't have to get steamrolled by this trend. They should facilitate and enhance the emerging market of 401(k) borrowing, rather than trying to impede it.

For example, most financial institutions that run 401(k) programs try to discourage participants from borrowing. These institutions don't want money flowing out of their collection of assets, so they build in barriers to borrowing.

A better approach would be to build liberal loan provisions into the 401(k) plan, and respect the intelligence of the participants to borrow wisely. These loan provisions should be marketed aggressively as one of the most attractive features of the 401(k).

More advice for bank management: Build your reputation for offering cost-effective 401(k) plans to employers. Losing a little loan activity to a 401(k) is an inexpensive price to pay for a significant bank-client relationship.

Mr. Butler is president of Pension Dynamics Corp., Lafayette, Calif, a consulting firm that designs and runs 401(k) plans for companies in Northern California. He is the author of "The Decision-Maker's Guild to 401(k) Plans."

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