The federal financial regulators have been urging depository institutions to offer payday loan alternatives since at least before the crisis. More recently, Consumer Financial Protection Bureau Director Richard Cordray urged banks and credit unions to implement policies to make it easier for consumers to obtain small-dollar loans. "I personally believe banks and credit unions can be low-cost providers of small-dollar loans," Mr. Cordray reportedly told The Wall Street Journal.
But in focusing solely on the payday loan alternatives offered by federally regulated depository institutions, policymakers appear to overlook the ascendance of Web-based companies helping to address gaps in consumer credit. Already, some marketplace and other online lenders are providing credit to underserved consumers and small businesses when banks and credit unions have chosen to hold back. So narrowly focusing on the traditional banking architecture to meet the needs of the underbanked overlooks emerging technology that expands credit to the very customers that regulators and consumer advocates want to reach.
The need to do something to reach the underbanked is most certainly there. Community banks and credit unions report reduced credit availability as a result of the compliance burden from the Dodd-Frank Act, according to a Government Accountability Office report. Similarly, the American Action Forum has estimated that revolving credit availability to consumers has dropped by 14.5%.
However, safety and soundness bank regulators — despite urging small-dollar alternatives — likely worry about the quality of underwriting for financial institutions that are in effect making riskier loans. And banks, worried about the resulting compliance burden and limited profitability, are disinclined to make these riskier loans.
Regulators are rightly concerned about banks using federally insured deposits to make loans with the types of risks that are more appropriate for private capital.
Tech companies can increasingly meet this demand, however. Marketplace lenders such as Lending Club, Peerform and Avant will make loans for as little as $1,000. Other companies like LendUp market small-dollar loans, claiming they are an alternative to a payday loan. PayPal uses a different model: financing purchases at the point of sale. Kabbage also offers consumer credit options, although for considerably longer terms than the typical consumer loan.
The companies use technology to identify potential customers, automate loan applications, expedite and expand underwriting criteria, and make lending decisions to provide applicants with quick access to cash, including to markets underserved by the traditional banking sector.
The online lending market is still small, however. It currently represents only about 1% of unsecured loans. But it is growing. For example, about $12 billion in marketplace loans were originated in 2014, according to a June report by Morgan Stanley. The report said marketplace lenders have focused in part on unsecured consumer credit, "with roughly 80% of loans used to consolidate debt."
Morgan Stanley estimates that marketplace lenders in the U.S. will grow to provide more than 8% of total unsecured consumer lending by 2020, fueled by almost 50% annual growth.
Rather than pressuring banks to make loans to underserved consumers that may not be supported by traditional underwriting criteria and safety and soundness concerns, regulators should focus on the following two things: one, identify regulatory barriers that limit the ability of the marketplace lending industry to expand their consumer offerings; and two, encourage bankers to work with innovative technology companies to expand lending opportunities beyond traditional markets and players.
Innovation and opportunity have the potential to make affordable lending to underserved populations a reality. Marketplace lenders can enhance credit availability and help other companies build a sound portfolio of borrowers they might not otherwise be able to reach.
Joseph Rubin and David Felt are attorneys at Arnall Golden Gregory LLP.