Federal regulators give the go-ahead for small installment loans from banks

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In July, the Federal Consumer Financial Protection Bureau (CFPB) lifted its 2017 balanced safeguards for payday and similar loans with terms of up to 45 days. This change will be a setback for the millions of borrowers who do not have this protection, but banks can help mitigate the damage.

Payday borrowers have checking accounts and incomes; Payday lenders require both as a condition for the loans. Many borrowers are looking for alternatives. Approximately 8 in 10 payday loan borrowers say they would borrow from their bank in lieu of payday loan if it offered small loans. However, banks were mostly on the sidelines due to regulatory uncertainty.

But in May, the Office of the Comptroller of the Currency, the Federal Reserve’s Board of Governors, announced the Federal Deposit Insurance Corp. and the National Credit Union Administration for the first time issued joint guidelines on their expectations for small dollar loans, which mitigated much of it uncertainty. This action is the result of years of research and consultation with industry and community stakeholders, as evidenced by previous statements and a formal FDIC request for information. As a result, banks are now well positioned to offer affordable small loans to their customers currently using expensive loans such as payday and auto title loans.

Regulators set principles for financial institutions and gave the green light to a simple, low-cost lending process. This is an important development because costly, time consuming, or difficult requirements to offer loans from a few hundred dollars make such loans unprofitable and therefore less likely for banks to offer them.

In particular, regulators have adopted low-cost, automated methods of assessing the repayment ability of loan applicants, including the use of “internal and / or external data sources, such as B. the deposit activity “. This means that banks can assess the creditworthiness of their own customers and grant loans without buying third-party information. This lowers the cost of lending for small installment loans or lines of credit and helps ensure fair pricing for consumers.

The FDIC also overturned a 2007 regulatory letter encouraging banks to lend at unsustainably low prices (no more than $ 24 for a three-month loan of $ 400, a price at which banks do not lend because they tend to lose money). This is important because banks can profitably make a three-month $ 400 loan for about $ 60, or six times less than the $ 360 average calculated by payday lenders.

Potential new bank offers vs. individual loans

Comparison based on average cost and affordability

Payday loan

Deposit advance

Potential new small installment bank loans or lines of credit

Borrowing fee of $ 500 for 4 months

$ 600

$ 400

$ 90- $ 100

Proportion of the next paycheck due on the loan

36%

27%

5%

Source: The Pew Charitable Trusts

The regulators included several borrower protection measures in their guidelines and encouraged banks to only provide loans “that support borrowers’ affordability and the successful repayment of principal and interest / fees in a timely manner, rather than follow-up debt”. The guidelines are intended to encourage the creation of programs in which “a high percentage of customers successfully repay their small loans in accordance with the original loan terms” and “discourage debt cycles due to rescheduling or borrowing”.

Banks are unlikely to meet these standards when offering single-payment loans, such as deposit advances. Similar to payday loans, these advances often result in repeated borrowing as they consume such a large portion of a borrower’s next paycheck. With installment loans and credit lines that have small, manageable payments that reduce the credit balance, these principles are easy to meet.

In addition, the CFPB issued a so-called no-action letter template in May, which offers additional legal protection for small loans from banks or credit unions. Such letters formulate basic conditions under which financial products would not raise regulatory concerns. The Bank Policy Institute’s no-action letter template encourages banks to offer loans with terms ranging from 45 days to a year. For the most part, these safeguards do not extend to payday loans or deposit advances with terms of less than 45 days.

Similar to the common guidelines, this template provides for a simple underwriting, “based on criteria including the transaction activity of the borrower on his accounts with the” [bank]”- a process more commonly referred to as cash flow underwriting. The letter also applies to loans that are “linked to a deposit account held by the borrower with the borrower”. [bank]“Which means that protection is only available for loans that banks and credit unions give to their own customers. This is appropriate because the loans banks make to non-customers are riskier and more costly, and are occasionally made through costly and risky partnerships with payday lenders who ignore government laws.

Despite speculation that banks will not be willing to lend to their small loan customers, Pew has had more than 100 conversations with executives at banks and credit unions on the subject and has found keen interest in small installment loans. In addition, the overwhelming majority of people say that they would see banks more positively if they offered such loans, even though the annual percentages would be higher than credit cards. In surveys, the public (80%) and payday loan borrowers (86%) consider the prices banks quote for charging such loans to be fair.

With the CFPB abandoning its consumer protection measures on short-term loans, small installment loans from banks would be helpful as most non-bank loans in this market remain extremely risky for consumers. Affordable bank credit options would create hundreds of dollars in savings annually for typical Americans using payday, property, hire purchase, and other forms of expensive non-bank credit today. Pew has published standards for these loans that allow banks to offer them quickly and profitably while remaining affordable to customers.

Nick Bourke is a director and Alex Horowitz is a senior research officer on The Pew Charitable Trusts’ consumer finance project.

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