WASHINGTON — The Obama administration will take another crack at testing the viability of small-dollar loan products when it releases its proposed 2017 budget on Tuesday.
The White House and other Democrats have long pushed for banks to offer affordable small-dollar loans as an alternative to payday loans and other costlier credit, but banks have struggled to make them profitable and safe for consumers.
"It's a challenge to make small-dollar affordable loans successful," said Nessa Feddis, senior vice president at the American Bankers Association. "It is a hard nut to crack."
Administration officials have been talking up the proposal, which will be part of Obama's final budget plan.
"This year's budget will propose a new small-dollar loan program to help CDFIs address the issue of predatory lending in their communities and provide an alternative to payday lenders," Treasury Secretary Jack Lew said in a speech last month, referring to community development financial institutions.
The government has previously experimented with other small-dollar loan programs. Between 2007 and 2009, then Federal Deposit Insurance Corp. Chair Sheila Bair implemented a pilot program with 31 banks. The program laid out parameters such as a maximum annual percentage rate of 36%, a minimum duration of three months and a maximum loan amount of $2,500. Bank participants said they had mixed results.
This time around, however, the program will provide funding to the CDFIs for loan loss reserves, something the FDIC pilot program did not include. Observers are optimistic the program could work.
"A program with the CDFI Fund can really help jump-start a market by making it easier for banks and credit unions to originate loans by helping them to mitigate their risk and once there are some clear guidelines in place in what those loans should look like, those loans could really achieve scale," said Nick Bourke, a director at the Pew Charitable Trusts.
David Pommerehn, senior counsel and vice president at the Consumer Bankers Association, said the industry is "actively searching for ways to make these types of loans to consumers."
But he said developing a viable product can be challenging because it needs to be easy for consumers to use and requires "soft-touch" underwriting to make it simpler to administer.
"Without those elements it really becomes a difficult product to sustain and most depositories won't offer it," Pommerehn said.
The ABA's Feddis noted that "lenders have fixed costs, and those fixed costs have to be recovered for the product to be sustainable." The revenue generated from the interest on a small loan might not always cover those costs, she said.
There are regulatory guardrails as well, including a proposal by the Consumer Financial Protection Bureau that is expected to cap APR rates for longer-term loans and restrict the size and frequency of shorter-term loans. Any small-dollar loan product offered by a financial institution would have to follow the CFPB rule.
Consumer groups, however, argued the CFPB rule could make it easier for reputable players to offer small-dollar loan products.
"We believe that rule will have a significant impact on the market — chasing away, we hope, the bad actors and allowing the good actors to thrive," said Gary Kalman, the executive vice president at the Center for Responsible Lending. "You want to make sure that things can go to scale and they are going to be accepted as an industry standard, and the best way that we view that happening is through a rulemaking at CFPB."
The CFPB rule will also have to be balanced with regulatory guidance from the FDIC and the Office of the Comptroller of the Currency, which have discouraged deposit advance products, and military lending rules that restrict the terms of products to military personnel and their families.
Pommerehn said the regulatory guidance has made some banks wary about entering the small-dollar lending market and stomped out the once popular deposit advance product.
"Deposit advance products that were low cost had very low default rates, were very well liked by the consumer that used them," Pommerehn said. "The OCC and the FDIC entered into supervisory guidance that basically meant those products go away."
But Bourke said the regulators were right to be skeptical of deposit advance products.
"The bottom line on deposit advance loans is they were not helping people get back on their feet," he said. "Deposit advance loans have the same problem that payday loans do. They are due back in full in two weeks and that takes a huge percentage of the average borrower's paycheck."
However, he said he thinks banks still have leg up on their nonbank competitors and can lend at rates six to eight times less.