When it comes to short-term, small-dollar loans, banks are between a rock and a hard place.
Consumers are demanding short-term credit, and officials such as former Consumer Financial Protection Bureau Director Richard Cordray have urged banks to meet this need. On the other hand, stringent regulation meant to shut down predatory lenders is understandably causing banks to hesitate about jumping into the market.
Many banks lack the technology to effectively underwrite these products. Partnerships with financial technology companies could be effective in helping banks meet both consumer and regulatory demands. But those partnerships continue to face a legal cloud. Thankfully Congress is considering adding a dose of needed clarity.
About 160 million Americans have nonprime credit scores or are credit invisible because they have no credit score at all. Most have incomes well above the poverty line, even above $100,000 a year, but they still cannot qualify for traditional loans. Lost jobs and mortgages in delinquency during the 2008-9 recession dented their credit scores. Or, take a recent college graduate with a bright career ahead but no credit history; he or she is not an attractive borrower to traditional creditors.
More Americans have incomes that swing month to month; coming up with even just $400 might be a challenge. Jobs tied to tourism, pay tied to tips or households where income earners may come and go all make for an uncertain income stream. Meanwhile, emergency expenses are a part of everyday life. Deposits for a first apartment, payments for higher education and moving costs require the same lump-sum payments as a medical emergency.
Americans need credit to smooth out the bumps in their financial and personal lives. But since the crisis, a lot of folks have had to fend for themselves. The Office of the Comptroller of the Currency recently spoke out on this problem: "As a practical matter, consumers who would prefer to rely on banks and thrifts for these products may be forced to rely on less regulated lenders and be exposed to the risk of consumer harm and expense."
Partnerships between banks and fintech firms could spur traditional institutions to get more involved. Fintech companies leverage big data to identify those with less-than-perfect credit scores who can pay back the loan. Highly regulated banks provide the credit and offer interest rates at a fraction of the cost charged by nonbank lenders. These partnerships are injecting competition into the short-term credit market.
Unfortunately, a few court decisions have ignored decades of legal precedent and put a cloud over these ventures by raising questions over which party is the "True Lender" in these partnerships. It's longstanding practice that rather than navigating the rules of 50 different states, national banks may charge interest in other states at the rate allowed by their home state.
However, these highly subjective "True Lender" tests create a risk that if a bank partners with a fintech, the fintech company, not the bank, might be deemed the true lender. Calling a fintech company the true lender is like telling a waiter that he or she is a great cook for delivering a good burger; the waiter deserves praise for good service, but the chef is responsible for the food. A few poorly reasoned true-lender cases have left well-intentioned lenders in legal limbo.
Fortunately, Reps. Trey Hollingsworth, R-Ind., Alcee Hastings, D-Fla., Blaine Luetkemeyer, R-Mo., and Henry Cuellar, D-Texas, recently introduced bipartisan legislation to clear up this regulatory mess by clarifying banks are the True Lender. This legislation will help banks provide millions of Americans more access to credit.
Critics assert these legislative approaches open the door to higher rate subprime lenders, but the loans covered by the bills are regulated like all other loans. They must be in compliance with guidelines from the Federal Deposit Insurance Corp., the OCC, the Federal Reserve Board and the CFPB, as well as state banking laws.
Moreover, critics miss the point. Regulation doesn't solve most problems, competition does. Legal clarity will unlock competition from banks and fintechs that will drive down prices, increase transparency and fuel innovation — all to the benefit of consumers.
Regulators want banks to oversee short-term credit and create more responsible lending. Consumers want banks in this market because they know and trust their bank. Congress can and should intervene promptly to fix the problems created by a handful of courts. It’s past time to get banks back in the business of lending to millions of disenfranchised individuals.