Most lower-income Virginians seeking loans of less then $5,000 have few options besides payday lenders. But a bill approved by the Virginia legislature might encourage more banks and thrifts to make such loans.

Virginia law caps bank and thrift fees on most kinds of loans at 2% of the amount borrowed. The pending legislation, which Gov. James S. Gilmore 3d is expected to sign, would remove that cap.

It was meant to protect consumers from high fees, but the result has been to discourage banks from making small loans at all, so people who wanted them were driven to payday lenders, which are not subject to the 2% cap and charge high interest to boot.

“Something that looks like a protection for borrowers has turned into a barrier,” said Mathew Street, associate general counsel for the American Bankers Association.

The 2% cap applies to all banks and thrifts operating in Virginia, regardless of charter. According to the American Financial Services Association in Washington, most states have caps on fees and interest rates. If the bill is passed, Virginia would be one of only 11 states that has no cap on bank and thrift interest rates and fees for installment loans.

Ray La Mura, the director of government relations for the Virginia Bankers Association, said the 2% restriction “made it impractical for banks to enter into the installment loan market.” If the law, scheduled to go into effect July 1, is passed, Mr. La Mura said, banks and thrifts would start making the smaller loans regularly.

Some consumer groups oppose the legislation, arguing it would give banks license to charge exorbitant fees. But Mr. La Mura predicted the opposite — that banks would position themselves as low-cost alternatives to payday lending outlets.

“This is a clear sign that financial institutions are entering the market of low-dollar loans that may fall prey to payday lenders,” he said.

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