It may take more than encouragement from the Trump administration for banks to re-enter the market for small-dollar loans after a five-year absence.
Concerns over profitability and shifting political winds could keep banks on the sidelines even though the Treasury Department and the Office of the Comptroller of the Currency would like to see them in the game.
Questions about how to offer small-dollar, short-term loans profitably, but without the triple-digit annual percentage rates sometimes charged by payday lenders, present challenges for the banking industry. Banks are also worried that such loans could fall out of favor under a future Democratic administration, Richard Hunt, the president and CEO of the Consumer Bankers Association, told Bloomberg Law.
“They’re going to have to enter eyes wide open, knowing that in another five years you may have another 180-degree turn by regulators,” he said in an Aug. 7 phone interview.
The Treasury Department encouraged banks to get involved in short-term, small-dollar loans that could serve as an alternative to payday lending in a July 31 report on ways to advance financial technology. That report came after Comptroller of the Currency Joseph Otting issued a May bulletin intended to spur banks to re-enter the market.
Jelena McWilliams, the new chairman of the Federal Deposit Insurance Corp., has also made statements supportive of banks issuing those loans, although the FDIC has yet to issue any bulletins or guidance about how those loans should look. McWilliams was the chief legal officer at Fifth Third Bank, which offers small-dollar loans, before taking over at the FDIC this year.
The support of Trump-era regulators for bank small-dollar loans marks a significant shift from the stance of financial regulators put in place by President Barack Obama. The OCC and the FDIC both issued guidance in 2013 essentially banning deposit advance products, which have characteristics similar to payday loans but typically carry lower interest rates.
The OCC, under acting Comptroller Keith Noreika, rescinded that guidance in October after the Consumer Financial Protection Bureau finalized rules for the payday loan market. The FDIC’s guidance remains in place for now.
The potential for a wild pendulum swing back to the Obama-era stance is a major worry for banks considering issuing those loans, Aaron Klein of the Brookings Institution told Bloomberg Law.
“That’s a legitimate concern by industry,” Klein, a former official in the Obama Treasury Department and Senate Banking Committee staffer, said in an Aug. 3 phone interview.
Beyond those regulatory concerns, banks are still struggling to find a small-dollar loan model that makes sense, industry watchers said.
The OCC’s May bulletin on small-dollar loans said banks should look to issue installment loans with terms of 45 days or longer. That model looks similar to one put forward by the Pew Charitable Trusts.
Such installment loans could allow for banks to charge interest rates in the high double digits — higher than credit card APRs or overdraft fees, but lower than payday loan levels. That could generate small profits while providing borrowers access to emergency credit, Alex Horowitz, a senior officer in Pew’s Consumer Finance Project, told Bloomberg Law.
“If banks are looking at a product that is going to be durable, and gain some support from consumers and regulators and stakeholders, then they need to look at terms of more than 45 days and loans that can be repaid in multiple installments and that have double-digit APRs,” he said in an Aug. 7 phone interview.
Because banks would be issuing loans to existing customers with deposit accounts, underwriting through cash-flow measures could be relatively quick if done through a digital offering, Horowitz added.
And speed is of the essence for short-term loans, according to Klein.
“People’s need for this small-dollar credit means that they’re willing to pay very large amounts for cash that shows up immediately. Speed is incredibly important in this market,” Klein said.
The CBA’s Hunt said those types of loan products would be “unworkable,” and that any banks that get back into small-dollar lending will look to the types of deposit advance products regulators previously frowned upon.
Six banks offered such products prior to 2013, and another 10 would be willing to get involved, Hunt said.
That may not make much of a dent in payday lenders’ ubiquitous market penetration, he said.
“We would need hundreds of banks in this program, not just six,” Hunt said.
Still, if banks are able to find a way to make profitable small-dollar loans, they will have some natural advantages over payday lenders, including speed and direct access to accounts. Payday loan borrowers all have bank accounts.
“They can do it cheaper than their nonbank competitors,” Jeremy Rosenblum, a partner at Ballard Spahr LLP who represents payday lenders and other financial services firms, told Bloomberg Law in a July 31 phone interview.
The question is whether banks will be able to find the right mix.
— With assistance from Lydia Beyoud.
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