Momentum is building for small-dollar loans
U.S. Bank’s announcement this week that it will begin offering a new small installment loan could be the start of a new era — one in which regulated banks and credit unions offer small-dollar loans that most consumers can afford.
The loan features monthly payments that don’t exceed 5% of a borrower’s monthly income, with prices markedly lower than the payday, pawn, auto title or rent-to-own loans for which the effective annual percentage rates often top 300%. A $400, three-month loan from U.S. Bank would cost $48, compared with about $350 from a payday lender.
This welcome development from a bank with more than 3,000 branches across the country could provide a safer option to consumers who have until now been largely excluded from access to affordable small-dollar credit. The announcement follows the Office of the Comptroller of the Currency’s May bulletin, which for the first time gave mainstream providers the regulatory certainty they need in order to offer affordable installment loans.
When the Pew Charitable Trusts surveyed payday loan customers about numerous possible reforms, the single most popular was enabling banks and credit unions to offer small loans at significantly lower prices than those charged by payday lenders. Pew research has found — and U.S. Bank’s actions now demonstrate — that banks and credit unions have such a large competitive advantage that they can offer loans at prices that are six to eight times lower than payday lenders and still make a profit. The annual percentage rates have to be higher than those on credit cards, of course, but neither the public nor the payday loan borrowers we surveyed see that as unfair as long as APRs do not exceed double digits.
Until recently, a lack of regulatory clarity on what is and is not acceptable has prevented banks from offering small loans. But that started to change even before the OCC announcement in May. First, in 2016, representatives of 10 banks and 10 nonprofit public interest organizations agreed on reasonable standards that would make large-scale, profitable, consumer-friendly small-dollar loans feasible. Then, last October, the federal Consumer Financial Protection Bureau issued rules that leave providers free to offer safe, small installment loans and lines of credit with few restrictions if the loans have terms of more than 45 days. At the same time, technological innovation has enabled automated underwriting and origination, with loan applications processed via mobile or online banking and the proceeds deposited into customers’ accounts the same day — saving banks money and time, and enabling consumers to borrow more quickly from banks than they can from payday lenders.
U.S. Bank is just one of several large, national banks that have shown interest in offering safe small installment loans to borrowers if permitted by regulators. Evidence suggests that these loans will be very popular and that as long as banks abide by strong standards for safety and affordability, consumers will be big winners. Americans spend more than $30 billion a year to borrow small amounts of money from lenders outside the banking system, and even in states to which payday lenders point as models, such as Florida, interest rates exceed 200%. So the potential savings to low- and moderate-income borrowers from gaining access to double-digit APR bank loans could top $10 billion annually — more than the federal government spends on many anti-poverty programs.
Credit unions have the same competitive advantages as banks, which would allow them to also offer small-dollar loans at scale if their regulator, the National Credit Union Administration, were to authorize them to do so. Its board chairman, Mark McWatters, took a promising step in that direction this year when he issued a request for comment about a new payday alternative loan program that could make these lower-cost small loans feasible for credit unions.
In the Pew survey, four in five payday loan customers said they would prefer to borrow from their banks or credit unions — and all these borrowers already had checking accounts, because it’s a requirement for getting a payday loan. A third of checking account customers who pay high fees to overdraw their accounts report that they do so as a way to borrow money when they’re short on cash; many of them are likely to use new bank or credit union small-dollar loans if they gain that option. Moreover, loan payments would be reported to credit bureaus to help customers establish a successful track record of repayment.
Standards for these small loans are necessary to protect consumers, enable automation and simplify regulatory compliance. Research shows that setting payments at 5% of income, as U.S. Bank has done, is affordable for borrowers while enabling lenders to be repaid over the course of several months. Some public interest groups and banks have already expressed support for this moderate standard.
The OCC appears to recognize that many bank customers currently have no good way to cover expenses when they’re in a financial bind and also appears to acknowledge the negative consequences of payday lending. By offering struggling customers safe credit, banks can solve both these problems with small installment loans. U.S. Bank’s announcement shows that offering such loans is possible without returning to the bad old days of “deposit advance” products that simply mimicked lump-sum payday loans.
To build on this success, the Federal Reserve Board and Federal Deposit Insurance Corp. should echo the OCC’s bulletin and give their supervised institutions the regulatory certainty they need to offer small installment loans. The CFPB should leave in place its 2017 small-dollar loan rule to protect consumers. And other banks should rise to the occasion and offer small-dollar installment loans — giving their millions of customers who today turn to high-cost lenders a much better option when it comes to borrowing money.