Uncertainty about CFPB has banks leery of small-dollar lending
The Trump administration has urged banks and credit unions to compete with high-cost payday lenders to offer more credit options to consumers. But banks remain wary of a product they still see as risky, observers said.
The prudential bank regulators issued guidance in May encouraging banks to embrace small-dollar lending to help consumers hurt by the coronavirus pandemic. Two days later, the Consumer Financial Protection Bureau approved a process for banks to offer installment loans or lines of credit for amounts of up to $2,500.
But nearly two months later, banks are still said to be balking at a product that the industry for the most part has long viewed with reluctance.
Bankers remain concerned about the profitability of such products. The upcoming presidential election, which can determine who leads the regulatory agencies, also raises questions about the durability of recent guidance.
“As quickly as these rules change, they can flip back, so for a bank to spend a lot of time and effort to create a product to fit this market and have the rules change a year from now, it’s hard to imagine they will do that work," said Doug Farry, co-founder of Employee Loan Solutions, a Solana Beach, Calif., technology company that helps employees qualify for low-cost small-dollar loans.
The recent stance of Trump administration regulators is in stark contrast to the warnings for banks from the previous administration about offering small-dollar loans.
But with the 2020 election less than four months away, polls favor the presumptive Democratic nominee Joe Biden. And a recent Supreme Court decision making it easier for the president to fire a CFPB director calls into question the job security of Kathy Kraninger, the agency's current chief.
So far, only a handful of banks offer well-known small-dollar lending products. U.S. Bank in Minneapolis offers loans between $100 and $1,000. KeyBank in Cleveland offers a KeyBasic line of credit between $250 and $5,000.
“This is going to take some time,” said Alex Horowitz, a senior officer at the Pew Charitable Trusts, who has talked with banks and service providers about creating small-dollar loan products.
Others suggested banks may wait for the political and regulatory environment to settle down since the election could result in a U-turn on regulatory policy.
If President Trump loses the election, many expect Kraninger's days would be numbered in a Joe Biden administration. The Supreme Court ruling allowed CFPB directors to be fired at will, striking down a statutory provision in the Dodd-Frank Act.
Richard Hunt, the president and CEO of the Consumer Bankers Association, said the court decision last month has upended plans by banks to develop small-dollar loan products.
“Banks want to serve their customers, but with uncertainty surrounding the U.S. Supreme Court ruling to create an at-will [CFPB] director during an election year, I would not expect many institutions to invest time and resources into a new product,” Hunt said.
The long-awaited guidance issued on May 20 by the Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, Federal Reserve Board and the National Credit Union Administration includes broad principles rather than prescriptive rules on how banks can safely originate small-dollar loans.
Horowitz called the guidance from prudential regulators “durable,” since it reflects the work over many years by career staff. As long as financial firms stick with longer-term installment loans that can be paid back over more than 45 days, they have protection from legal liability, he said.
Moreover, regulators only gave banks a green light to offer installment loans, not payday loans of less than 45 days. Payday loans have drawn the ire of past regulators and consumer advocates for pushing borrowers into a debt spiral by repeatedly rolling over loans, prompting the CFPB to write its 2017 payday lending rule that the CFPB recently overhauled.
“The political and regulatory risk is all on the side of loans with 45-day terms or less,” Horowitz said.
Just after prudential regulators released their guidance, the CFPB released an approved template for banks to use in seeking a "no-action letter" — designed to allow companies to develop products without fear of supervisory action — to offer installment loans or lines of credit for amounts of up to $2,500. The template was requested by the Bank Policy Institute, a Washington trade group.
But banks are gun-shy about offering small-dollar loans not only because federal policy could change but also because they worry the loans are not profitable, many observers said.
While many applaud the efforts of the CFPB and federal regulators to increase competition for small-dollar loans, there remains a major underlying economic difference in how banks and small-dollar lenders produce and collect on loans. Banks tend to focus on a relatively small number of large loans, each with a low chance of default, rather than a large portfolio of small loans, each with a higher probability of default.
"Even with encouragement and guidance from regulators, banks still have to find a way to make the economics work,” Farry of Employee Loan Solutions said.
Still, when the coronavirus began spreading in the U.S. in late March, demand for U.S. Bank's Simple Loan jumped initially, said Lynn Heitman, executive vice president of product strategy and support at the bank.
Heitman said U.S. Bank responded by dropping the pricing on the three-month loans to $6 for every $100 borrowed, down from between $12 to $15 for every $100 borrowed.
“That was absolutely an effort to help our customers during a very difficult time,” said Heitman, who expects to phase out the lower pricing over the next month or so because demand has abated. “We designed the product to have three legs of a stool: to be sustainable, accessible and transparent so the pricing and terms are easy to understand.”
The loan's annual percentage rate of 70% to 88% may seem high, but it includes borrower protections recommended by Pew. Payments cannot exceed 5% of a borrower’s monthly income and there is a 30-day wait period between paying off one loan and applying for another.
Heitman said she has received inquiries from other banks and trade groups about how to structure small-dollar installment loans. She cautions that many factors are at play in how consumers manage their money.
“This is a very different product,” she said. “The need is there, the pricing is fair, but there's more unknown than there is known.”
Ben Morales, the CEO of Q-Cash Financial, a unit of Washington State Employees Credit Union, said he expects banks and credit unions that ultimately decide to offer small-dollar loans will partner with fintechs and others that have automated the process.
"The challenge banks are having is how to do this effectively and profitably," Morales said.
Some nonprofits and credit unions have been offering small-dollar loans for years at far lower costs compared with payday loans. But banks still see the space as filled with risks.
“Ten years ago there was nobody offering loans with annual percentage rates in between 36% and 465%, and now U.S. Bank is there with 70%,” said Paul Woodruff, executive director of Prosperity Connection, a St. Louis nonprofit that has offered small-dollar lines of credit to low-income consumers since 2007. "If you are operating a bank and now there's a mandate to offer loans that lose money, enhance risk and have all these expenses associated with it, that's a no-win situation."