The Office of the Comptroller of the Currency’s new guidance represents an important welcome mat to bring banks into installment lending and to provide credit alternatives to nonprime consumers.
Banks have been largely out of the short-term consumer credit market since 2013, when the OCC and the Federal Deposit Insurance Corp. both issued guidance that drove the discontinuation of deposit-advance lending. To many, deposit advances look a lot like payday lending: They require a balloon payment the next time the customer gets paid — generally within two weeks. While some consumers used a deposit advance successfully, others found themselves in a trap. Payday and deposit advance products generate most of their revenue from the minority of users who can’t repay without reborrowing. As a result, the loans tended to deepen customer indebtedness.
Yet, in Comptroller Joseph Otting explicitly encouraging the installment loan structure with an ability-to-repay principle, the industry now has a better way to ensure debt taken on to meet an emergency can be paid off in a short period of time, leaving credit available for the next emergency and bolstering resiliency.
The OCC recommended banks offers loans that borrowers will pay off over a period of two to 12 months and that lenders look at deposit activity, among other data, to underwrite loans. The combination of longer term payback periods and more meaningful underwriting standards will allow banks to minimize the number of loans they grant to consumers already underwater. Banks’ ability to see and analyze earning and spending patterns of their account holders gives them an advantage in managing risk and minimizing long-term harm — both to the consumer and to the institution.
Installment loans have another advantage in that they can establish patterns of successful repayment that are recognized by widely used credit scoring models such as FICO and VantageScore. If reported to the three main credit bureaus, such loans could potentially enable consumers with deep subprime scores to improve their performance, and ultimately, obtain access to cheaper forms of credit, such as credit cards.
Yet while banks’ reentry into the installment lending market would be a net positive, it won’t solve all problems. Installment loans are not a perfect substitute for all payday loans. The Consumer Financial Protection Bureau has a critical role to play in reining in the payday market and in creating workable standards for nonbank lending. Many online and storefront payday lenders have already moved to installment loans in anticipation of the CFPB’s payday rule, which faces uncertainty under acting Director Mick Mulvaney. Many such loans come with triple-digit interest rates and frequent rollovers, which simply digs the hole deeper for financially challenged consumers.
Nor will installment loans keep cash-strapped consumers from overdrafting. Overdraft fees generate roughly twice as much revenue for banks and credit unions as the fees payday and auto title lenders generate. Indeed, CFPB analysis of deposit advance users showed they overdraft heavily, even while using a credit product billed as a way to avoid overdraft.
That’s why better short-term credit alone will not improve the financial health of consumers who rely on the product — even if it is cheaper and lets them pay back debts owed over a longer period of time.
For consumers who chronically spend more than they earn, only income boosts or expense reductions will make a difference in the long run. Loans may be of greater help to consumers who contend with volatile income or unexpected expenses, but only in the short term. Positive developments around cash flow management and saving are critical complements to loans. Companies with low-wage employees and gig workers are letting consumers name their paydays to effectively accelerate the velocity of earnings without exacerbating the underlying financial vulnerability of their users. There are also newer savings tools such as those offered by Digit and Simple that help people stick to their resolutions to set money aside for emergencies so that they can avoid overdrafting or resorting to short-term credit.
Over the last few years, a small but growing number of banks have built suites of deposit products, digital tools and online advice to help financially vulnerable customers manage cash flow, optimize bill payment and plan ahead. The missing piece, they believe, both to meet consumer need and to bolster the business case, has been credit. Now that the OCC has offered up that piece of the puzzle, banks will have no excuse. Let’s hope they leverage the new guidance, along with their record profits, in ways that truly benefit the customer.