FDIC's small-dollar riddle: How to entice banks, yet stay tough

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WASHINGTON — Scores of consumer groups, state authorities and others are urging the Federal Deposit Insurance Corp. to maintain controls on small-dollar loans if the agency proceeds with a plan to enable banks to compete with payday lenders.

The FDIC's request for information, published in November, on how to regulate small-dollar lending drew myriad opinions from commenters calling on the agency to support interest rate caps and restrict banks' use of nonbank partners to develop loan products. State officials, meanwhile, defended their authority to enforce consumer protection laws.

“State regulators oppose any federal agency action that fails to respect the ability of states to control interest rates and impose additional consumer protections for small-dollar credit products,” John Ryan, president and CEO of the Conference of State Bank Supervisors, said in a letter to the FDIC.

The agency is exploring how to reopen small-dollar lending options for banks as the industry says tighter regulation in recent years has made it nearly impossible for them to enter the business and therefore pushed consumers to seek nonbank options. In 2013, guidance issued by the FDIC and the Office of the Comptroller of the Currency effectively banned banks from offering deposit advance products.

In interviews and among the more than 60 comments submitted to the agency, a key area of contention is how to make small-dollar loans affordable for consumers yet profitable for banks at interest rates that don’t exceed various state caps.

Consumer groups are urging the FDIC to retain the deposit advance guidance; the OCC rescinded its guidance in 2017. Commenters also want the FDIC to impose a 36% cap on annual percentage rates for banks' small-dollar lending. The agency encouraged institutions to stay under that APR limit in a 2007 guidance on "affordable small-dollar loan products," and a 36% cap is used in federal law restricting the terms in credit products sold to military service member.

“The FDIC should maintain their long-standing guidance that small-dollar loans should be at 36% or less,” said Lauren Saunders, associate director of the National Consumer Law Center. “Loans above that rate really risk being unaffordable for consumers and lead to practices where lenders can become more predatory.”

After the OCC's rescission of its deposit advance ban, the agency released a bulletin this past May authorizing national banks to compete with payday lenders. The bulletin encouraged banks to make small-dollar installment loans of 45 days or more to borrowers with FICO scores of 680 or below.

Industry groups are hoping the OCC and FDIC ultimately follow the same path on a small-dollar lending policy.

Currently, with the two separate tracks, “it creates uncertainty and even if a bank is not regulated by one of those agencies, they still take that to heart and for their reputation,” said Richard Hunt, president and CEO of the Consumer Bankers Association. “It’s better that all the regulators are on the same page.”

But the FDIC has been more cautious, instead choosing to follow a longer process and field comments before taking any action, which many consumer groups see as a positive sign.

“If I wanted to just . . . rescind the guidance, I could have done that on June 5” after taking office, FDIC Chairman Jelena McWilliams said in November during an interview announcing the RFI. “What I’m trying to do is make an informed decision here. And that decision is best made if we involve the public and get comments from both the banks and the consumer groups, and the consumers themselves.”

At the same time, many lenders say interest rate caps and other restrictions are a major factor in why they left the small-dollar business.

“While we understand that Annual Percentage Rate ... is the universally accepted standard in the industry for measuring the cost of credit, it can be argued that APR does not fairly measure the cost of convenience that a consumer is willing to pay for a small dollar loan,” wrote Rajive Chadha, head of consumer products and origination partnerships at Regions Financial Corp.

The Alabama bank had offered a deposit-advance product called Ready Advance in 2011 but got out in 2013.

“Further, an APR calculation is difficult to perform on an open-end line of credit, such as Regions' prior Ready Advance product,” Chadha said. “Focusing on the APR also loses sight of the fact that these types of loans, including Regions' product, are less costly than small dollar loans from other sources such as payday lenders.”

Former FDIC chair Sheila Bair also wrote to the agency, suggesting it keep the 36% interest rate cap with some flexibility for smaller loans in order to make it a viable option for banks. Bair ran the FDIC when it released the 2007 guidance and completed a small-dollar loan pilot project in 2008.

“Larger, longer term loans have flourished using the 36% target rate contained in the FDIC guidance,” she wrote. “However, rates above 36% may be necessary for loans of just a few hundred dollars to stimulate more competition, even though unnecessary for loans of a few thousand dollars.”

Bair also emphasized that the FDIC should give banks the ability to streamline underwriting, including using alternative credit data and third-party service providers.

“Service providers to banks offer ready-to-use turnkey platforms that can process an application, underwrite a loan, and deposit funds into the borrower’s account, all within a few minutes,” Bair wrote. “One benefit of banks’ lending to their own customers using new technology is that they can be faster than payday lenders, as they have a better knowledge and understanding of their borrowers through their pre-existing relationships.”

Some nonbank lenders and fintech firms also suggested that the FDIC should clarify its policy on bank partnerships, including that the interest rate originally set by the underwriting bank stay the same for the life of the loan, regardless of whether it is sold. This practice, known as the “valid when made” doctrine, has been challenged by a 2015 court ruling and is heavily opposed by state regulators.

“To ensure safety and soundness, it is crucial that small loans can be sold into the broad credit market with loan contracts remaining enforceable on their original terms,” wrote the Marketplace Lending Association, which set a 36% APR cap for its members. “Indeed, the valid-when-made doctrine is critical to a healthy financial system, small businesses, and consumers because it ensures liquidity in the credit markets, thereby reducing the cost of credit to borrowers.”

However, state authorities and many consumer groups suggest that the FDIC restrict partnerships that would create a so-called rent-a-bank, in which a partner uses the bank’s preemption rights to charge interest rates above state usury caps.

“Banks should not enter into partnerships with state-regulated lenders in order to facilitate high-rate loans that would otherwise be illegal,” wrote 88 consumer, community and religious groups including the NCLC and the Center for Responsible Lending. “If sanctioned, these schemes pose an existential threat to the greatest protection against predatory small dollar loans: state interest rate limits. It is essential that the Agency put an end to these schemes and prevent new ones from emerging.”

Despite differing opinions on how to regulate small-dollar lending, Bair said the FDIC has options to encourage banks to get back into small-dollar lending without having to rescind pre-existing guidance.

“For instance, the FDIC could issue updated guidance, launch another pilot, or create a regulatory sandbox for experimentation in the small dollar loan space,” she said. “Again, the approach should tolerate some reasonable flexibility on rate and underwriting.”

However, she added that the FDIC's path forward “will be tricky,” especially since small-dollar lending attracts consumers in dire financial need.

“They need to proceed carefully,” she said. “That’s why it was smart to start with an RFI.”

Even Dollar Loan Center, an alternative online lender, encouraged the FDIC to bring banks back in as competitors by loosening underwriting standards and not setting an APR cap.

"Without expanding banks’ provisions of small-dollar credit products, an increasing number of consumers are likely to turn to alternative lenders, many of whom may be offshore and that are less focused on consumer protection issues," Dollar Loan Center said in a letter to the FDIC. "This in turn will likely lead to a greater risk of default, thus compounding the divide between the banked and underbanked (and unbanked) populations."

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