More Competition Is the Answer to Small-Dollar Credit Woes
The place to debate whether payday lending or any other business should be allowed to operate and have access to the banking system is in the halls of Congress and state legislatures, not in the backrooms of government bureaucracies, Bill Isaac writes.April 22
The new American Express film Spent offers an opportunity to consider some emerging strategies aimed at helping low-income and struggling middle-class Americans avoid or get out of debt.June 20
This is the first in a two-part series adapted from a keynote speech delivered at the annual meeting of the Financial Services Centers of America, a trade group representing nonbank financial services companies.
These are hard times for payday lenders and many other alternative financial services companies. Bank regulators as well as the Department of Justice's Operation Chokepoint are forcing firms offering small-dollar loans, check cashing, money orders and other services vital to working Americans out of the banking system.
The industry's struggles go way back. More than a decade ago, the Comptroller of the Currency decided to prohibit short-term lenders from distributing their loans through national banks.
I was sympathetic to the Comptroller's position that problems arose when nonbanks avoided complying with state laws by effectively renting a national bank charter. But I believe a better outcome for consumers would have been for federal bank regulators to allow and even encourage banks to directly engage in short-term lending, check cashing, and other similar consumer products and services. That would have introduced more competition and better pricing for the services so desperately needed by low- and middle-income customers and ensured that those services were subject to appropriate regulation. I believe a similar solution would work today.
Instead of trying to remove lawful firms from the marketplace for alternative financial services to lower-income households, we should encourage more competitors to enter this space. Competition is the only practical way to ensure that markets are efficient and offer the best services on the best terms. Regrettably, current public policy is headed in the opposite direction.
Until about a year ago, four relatively large banks Regions, Fifth Third, U.S. Bancorp and Wells Fargo offered a deposit advance product that was competitive in the short-term loan space. Each bank has since dropped the product, reportedly in response to regulatory pressures.
The rationale behind regulators' actions is a complete mystery to me. The deposit advance product was popular with customers, particularly among people with lower incomes, and profitable for the well-regulated and highly-regarded banks.
Given that nearly one-quarter of the U.S. population has limited or no participation in the country's banking system, I would think that regulators would be working with banks to find ways to improve and expand their offerings to moderate- and lower-income customers rather than forcing banks to give up products aimed at this segment.
If I were the chief executive of a regional bank, and if I could get a green light from the regulators, I would seriously consider purchasing a firm offering alternative financial services. I would then run it as a free-standing business serving low-to-moderate income customers, educating them and nurturing them to become customers of the bank in due course.
Of course, in the current regulatory environment few, if any, banks would be willing to take on the risk associated with products that serve the needs of this population segment. Our government has devoted enormous amounts of time, energy and money during the past six years heaping new regulatory burdens on banks and imposing staggering fines. The more liability and risk we impose on banks for such things as anti-money laundering violations, failing to properly supervise vendors and problems with mortgage origination, servicing and collection practices, the more risk-averse banks become.
This is the wrong direction for our banks and our nation. The unintended consequence of our misguided policies is that the very people and companies who most need basic, regulated financial services are the ones banks have the most difficulty reaching. Meanwhile, cash and the shadow banking system are playing an-ever larger role in the economy, resulting in less transparency about suspicious activities and greater potential threats to financial stability.
These issues are not confined to the U.S. People in countries throughout the world are in danger of being cut off from the global banking system because of foreign firms' inability to implement anti-money laundering regimes that are satisfactory to the U.S. government. In a retreat from prior U.S. policy that recognized the value of the transparency created by including more people in the mainstream financial system, recent public enforcement actions and strong statements by regulators and law enforcement officials have incentivized financial exclusion.
Many of the foreign banking systems that are most affected by this issue are in poor regions that have dire need of global banking services. I don't believe it serves U.S. interests if those countries' economies deteriorate further and their citizens' banking transactions go underground.
In these and so many other areas, the federal government is inappropriately pushing banks to de-risk, which in reality is causing banks to purge the people and businesses most in need of access to the financial system. This is hurting the economy and creating hardship for millions of people worldwide.
The federal government should encourage banks and nonbanks alike to offer short-term, installment and title loans and other forms of access to small-dollar credit. We should encourage banks to get into the small-dollar credit business, either by forming partnerships with alternative financial services companies or by merging with them.
This would increase competition and bring down prices, giving consumers more and better options, and allow all firms to participate on a level regulatory playing field. And it would bring tens of millions of underserved customers into the banking system.
William M. Isaac, former chairman of the Federal Deposit Insurance Corp., is senior managing director and global head of financial institutions at FTI Consulting, which represents many clients throughout the world, some of which have interests in the issues considered in this article. The views expressed are his own.