The Office of the Comptroller of the Currency is shaking up the world of short-term lending by encouraging banks to offer high-interest rate loans to subprime borrowers as an alternative to payday lenders.

In a major break from past regulators, Comptroller Joseph Otting said Wednesday that he wants banks to originate loans of $300 to $5,000 to borrowers with FICO scores of 680 or below, with few other parameters beyond "sound underwriting." The new OCC guidelines could open a $90 billion market to financial institutions.

"This product is a vehicle to help people get back into mainstream banking and get them off of high-cost financial services products of check-cashing and payday lending, with a view toward getting them into the mainstream of financial activities where they can qualify for a credit card," Otting said on a conference call with reporters.

Joseph Otting
"This product is a vehicle to help people get back into mainstream banking and get them off of high-cost financial services products of check-cashing and payday lending," said Comptroller of the Currency Joseph Otting. Bloomberg News

"I personally believe banks can provide that in a safer, sound more economically-efficient manner."

The OCC issued a bulletin clarifying its guidance on short-term, small-dollar installment loans, but said the agency did not conduct research before the release. The bulletin did not create a new rule or change existing guidelines. The move followed earlier calls by the Pew Charitable Trusts and others for regulators to enable banks to compete more directly with payday lenders.

Pew and banking industry groups had previously urged the Consumer Financial Protection Bureau under former Director Richard Cordray to include provisions allowing banks to more easily make installment loans in the agency’s recent payday lending rule, but the CFPB ultimately balked.

"The position outlined by the Comptroller is a welcome step that should help pave the way for banks to offer safe, affordable small-dollar installment loans to the millions of Americans that have been turning to high-cost nonbank lenders," said Nick Bourke, director of Pew’s consumer finance project. "If banks begin offering these loans according to strong safety standards, it could boost financial inclusion and be a game-changer for the millions of Americans who use high-cost loans today."

Otting said banks need clarity from regulators before marketing small-dollar lending products.

"A lot of banks wanted to hear from us that we were supportive of them entering the market and doing it below historical underwriting standards," Otting said. "This is the signal that they have been looking for."

Richard Hunt, the president and chief executive officer of the Consumer Bankers Association, said “regulatory uncertainty forced banks out” of small-dollar installment lending.

That left “families to rely on pawn shops, costly payday lenders or loosely regulated online lending during times of financial stress,” Hunt said. “This guidance sends a clear signal bankers can help customers receive short-term loans within the well-regulated, cost-effective banking system.”

Banks could provide installment loans to between 25 million to 50 million consumers that currently get payday loans, Otting said.

"Banks may not be able to serve all of this large market, but there is some percentage they can serve by having acceptable [debt-to-income ratios] and payment terms that promote the long-term financial goals of their customers," he said.

"Generally what happens is those consumers have fallen to a lower common denominator in order to have that product ... often check-cashers, payday lenders, pawn shops and liquor stores."

The OCC has not put any specific parameters around bank installment loans beyond an ability-to-repay principle. It is unclear whether OCC examiners will require that banks consider a borrowers' other existing obligations such as rent, and child support when determining their ability to repay.

Otting said banks can make loans with "slightly higher [debt-to-income] ratios than normal and lower credit scores historically, but we do expect banks to do that in a safety and sound manner."

Banks are free to structure loan products with high interest rates and any terms as long as they "support borrower affordability and successful repayment of principal and interest in a reasonable time frame," the OCC said.

Banks got out of short-term lending in 2013 after the OCC and Federal Deposit Insurance Corp. during the Obama administration issued regulatory guidance that led to the demise of so-called deposit advance loans, which bore a resemblance to high-cost payday loans, with average interest rates around 300% even though they were made by banks.

Consumer groups generally viewed deposit advance as predatory; past regulators considered them inconsistent with safety and soundness.

While Pew has repeatedly argued that bank-issued small-dollar loans would be a better alternative for consumers who need credit and who currently seek out other lenders, other consumer advocacy groups reacted negatively to the OCC announcement.

"The OCC is replacing the 2013 policy with a new, weaker guidance that will tempt banks back into the subprime small dollar loans," said Christopher Peterson, a senior fellow at the Consumer Federation of America and a University of Utah law professor.

Critics pointed to the lack of any interest rate limit as a weakness in the OCC guidelines. For example, many states have set a 36% cap on annual percentage rates, which is the same limit used in a federal law dealing with loans to military service members.

"The OCC's guidance underscores that costs must be reasonable and loans must be affordable," said Rebecca Borné, a senior policy counsel at the Center for Responsible Lending. "Adherence to these principles means that the annual percentage rate on bank loans should not exceed 36%. In addition, banks should only make loans that borrowers have the ability to repay while meeting other expenses."

Consumer groups consider an “all-in” usury limit to be the most effective form of consumer protection for small-dollar, short-term loans.

Without a hard price limit in the OCC guidance, “many banks will be tempted to impose crushing rates and fees on borrowers," said Peterson.

But Bourke said other federal bank and credit union regulators should follow the OCC's lead and institute "necessary standards to ensure the development of safe and affordable small installment loans that will save millions of borrowers billions of dollars a year.”

The OCC's deposit advance guidance was rescinded in October 2017 after the CFPB finalized the first federal rule regulating payday lenders.

The OCC said in a press release that continuing that guidance "would have subjected banks to potentially inconsistent regulatory direction and undue burden as they prepared to comply with" the CFPB's payday lending rule.

The payday rule is being reconsidered by the CFPB and likely will be changed without a key requirement that lenders determine a borrowers' ability to repay the loan. Payday lenders have lobbied heavily to change the payday rule, claiming it would put them out of business.

In a statement, current acting CFPB Director Mick Mulvaney, who has aggressively sought to roll back many Cordray-era policies, hailed the release of the OCC bulletin.

“Millions of Americans desperately need access to short-term, small-dollar credit. We cannot simply wish away that need," Mulvaney said. "In any market, robust competition is a win for consumers. The Bureau will strive to expand consumer choice, and I look forward to working with the OCC and other partners on efforts to promote access and innovation in the consumer credit marketplace.”

Richard Taft, the OCC's deputy comptroller for credit risk, said that some banks already offer installment loans products while others have been testing them over the past 60 days. The OCC declined to name any banks currently offering such loans.

Otting said he has been talking to bankers and consumers since taking the job in November, and many want banks to offer products that rival payday loans but that have longer terms.

"The No. 1 complaint people had was that national banks were not providing credit to consumers below 680 Fico scores," Otting said. "It's not like credit demand went away, it just got displaced to places that are the most expensive for consumers."

The OCC did offer three core lending principles, including that the loans should be consistent with "safe and sound banking, treat customers fairly and comply with applicable laws and regulations."

Banks are expected to manage risks of the loans, and all credit products "should be underwritten based on reasonable policies and practices, including guidelines governing the amounts borrowers, frequency of borrowing and repayment requirements."

The CFPB's payday rule included a carve-out for banks or credit unions that make 2,500 or fewer short-term or balloon payment loans per year, or derive less than 10% of their revenue from such loans. Banks still can offer short-term loans of 45 days or less, but such payday loans would be regulated by the CFPB, not the OCC.

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