Is now the time when U.S. banks, credit unions and their regulators finally see eye to eye on small-dollar loans to consumers who have checkered credit histories?
A long-running stalemate between the industry and its overseers has ceded much of the subprime consumer market to payday lenders, pawn shops and other high-cost lenders. But in recent months, banks started to get some insight from Washington about what type of product would be deemed acceptable.
Now the Pew Charitable Trusts, which has been seeking a compromise that benefits both depository institutions and cash-strapped consumers, sees an opportunity for a breakthrough.
On Thursday, the nonprofit organization released a set of 10 recommended standards for banks and credit unions that want to offer small-dollar loans to subprime customers. Pew favors installment loans that include multiple payments over lump-sum products that often lead to a debt cycle.
Among its proposed criteria: payments should not exceed 5% of the borrower’s paycheck; annual percentage rates should be below 100%; and the loans should be available quickly through digital banking channels.
“Consumers need a better option than the harmful loans that dominate the market today,” said Alex Horowitz, senior research officer at Pew’s consumer finance project.
Horowitz argued that the Pew proposal could save U.S. consumers $10 billion annually in fees, while also allowing banks and credit unions to earn sufficient profits.
That is partly due to certain advantages that banks and credit unions have over payday lenders, including lower borrowing costs and a branch network that does not depend on profits from small-dollar loans. And it rests partly on the assumption that banks and credit unions will use automated underwriting processes instead of more old-fashioned techniques.
Just as notable as the content of the Pew recommendations is the timing.
U.S. banks have long been on the sidelines of this market, largely because the interest rates deemed acceptable by their regulators have been too low to earn what banks see as a sufficient profit.
But a confluence of recent developments in Washington suggests that banks may finally see a more enticing opportunity.
Last October, the Consumer Financial Protection Bureau released its long-awaited rule on payday lending, which gave depository institutions a new degree of clarity about the expectations of their regulators.
The CFPB rule does not apply to loans of 45 days or more, which suggests that banks and credit unions will face fewer constraints if they offer installment loans instead of products that more closely resemble payday loans.
Meanwhile, the arrival of Trump administration appointees at various banking agencies suggests that regulators are likely to become less skeptical of APRs that exceed the rates charged on credit cards.
During his Senate nomination last summer, Comptroller of the Currency Joseph Otting lamented Obama-era decisions that led some big banks to stop offering the kind of small-dollar consumer loans that are often a last resort for financially strapped consumers.
“I think they should be put back in the banking sector,” Otting said.
There is support in the banking industry for at least some of the ideas put forward by Pew. U.S. Bancorp, Regions Financial and Fifth Third Bancorp have all endorsed a cap on payments at 5% of the borrower’s paycheck.
Still, it is unclear exactly how many banks and credit unions want to offer the kinds of loans that Pew is proposing.
One of Pew’s recommendations is that loan payments should not trigger overdraft fees, which would likely take a bite out of the more than $15 billion that banks collect annually in overdraft fee revenue.
It is also not clear whether subprime consumers will choose less expensive bank loans over payday lenders, auto title lenders and the like, since many consumers like the speed and certainty those companies provide.
“A lower price point and more affordable payments is not enough,” Horowitz acknowledged.
Still, he said that subprime borrowers would prefer to turn to their bank. In a 2016 survey commissioned by Pew, 81% of payday loan customers said they would prefer to borrow from a bank or credit union if they were equally likely to be approved.
Pew is endorsing APRs above the 10%-25% range that is typical in the credit card industry, as long as they remain in double-digit territory.
Banks would be wise to avoid triple-digit APRs even if Trump appointees prove to be amenable them, Horowitz argued. He said that banks have an interest in offering products that are acceptable to regulators no matter who is in power in Washington.
“This kind of approach is durable,” he said.