Small dollar loans can be very profitable. Just look at the number of payday loan stores in the United States, there are over 20,000 of them. The reason they can be so profitable is that four out of five payday loans are rolled over or renewed. according to the CFPB. For the most part, banks have stayed away from actively promoting a low dollar lending product, and the FDIC wanted to know why and what terms might cause them to offer it.
Thus, in November, the FDIC issued a Request for information on small loans. They received more than 60 responses banks, industry associations, nonprofit groups, fintech companies and individuals. While each group had a slightly different perspective, there was a recognition of the challenge of making small dollar loans both affordable for consumers and profitable. Although the FDIC did not define exactly what it meant by a small dollar loan, respondents, for the most part, interpreted it as loans under $ 5,000.
There are many traditional online lenders offering personal loans up to $ 1,000 and there are also many fintech companies offering loans under $ 1,000. Companies like Oportun, Insikt, LendUp, Elevate, Opploans and many more are offering these loans under $ 1000 using the latest technological tools to make this process more efficient. Often these companies partner with banks to facilitate these loans to underserved consumers. But there are few banks that directly offer online loans under $ 1,000, with the notable exception American Bank. Interestingly, they did not respond to the FDIC’s request.
Many industry associations responded and I summarize some of those responses below.
The Market loan association (MLA) provided a detailed 10-page response where they urged the FDIC (and other regulators) to do more to support banks and foster closer working relationships with fintech vendors:
This includes establishing regulatory clarity on the completion validity principle that was undermined by the Madden decision of 2015, and finalizing the draft IDF-50 Third Party Lending Guidance to help guide the process. how banks can and should manage a bona fide third party. -the party loan arrangement. As the FDIC reviews the finalization of the FIL-50, it can also address unnecessary “real lender” uncertainty resulting from some older abusive partnerships between payday lender and bank.
The MLA has also advocated for the growing role of new types of partnerships between banks and fintech companies that can deliver better outcomes for consumers:
Evidence from a variety of sources including Transunion, dv01, Federal Reserve researchers, and academic researchers indicate that innovative banks, working in various ways with technology providers, such as MLA members, are helping to bridge these critical gaps and providing a responsible “smaller dollar”. credit options to the millions of Americans who need them. These partnerships are well regulated and clearly bring benefits to consumers, banks and our economy.
The American Bankers Association (ABA), the main trade association of the big banks, explained that many of their member banks offer small loans, but only a minority offer these loans as part of an established program. The obstacle, according to the ABA, is the 2013 FDIC directive on direct deposit advances which made it very difficult for banks to take out small dollar loans:
ABA believes that the banking sector can and should continue to be a major player in this market, but the costs, complexity and compliance risks presented by the existing regulatory framework are obstacles for banks making these loans.
The ABA also shared some findings from a survey it conducted last year into small dollar loans:
An ABA survey in March 2018 found that 10% of consumers surveyed said they had taken out a personal loan of less than $ 5,000 (not including credit card use) in the 12-month period leading up to the survey, a large part of the population. However, less than half of those borrowers – 43% – received the loan from a bank or credit union, despite evidence that consumers would like to meet their small credit needs with bank loans. More than two-thirds of survey respondents – 68% – expressed support for policy changes that would encourage banks and credit unions to offer small loans.
The Independent Community Bankers of America recommended, unsurprisingly, that community banks should be the primary vehicle for providing small dollar loans to consumers. An interesting idea they had is that these small dollar loans should be factored into CRA credit because of the difficulty in making these types of loans profitable:
Small loans are not a profit center for community banks. In fact, community banks often lose money because the fees and interest do not cover the costs of taking out and processing the loan. Even though these loans do not contribute to their profits, community banks provide these loans because it is part of serving the communities in which they do business. We recognize that it is premature for the FDIC to take action against the ARC given current modernization efforts, however, given the direct link between community banks and their investments in the community, the ICBA believes that providing a presumption of CRA credit for small loans encourage them to offer low value loan products purchased with caution.
The Center for Responsible Lending gave one of the most detailed responses to the RFI, 38 full pages. They took the FDIC to task on the demand for credit perceived as unmet:
We read with concern the RFI’s focus on what the FDIC’s unbanked / underbanked report sees as “unmet demand” for consumer credit. The metrics used to measure “unmet demand” do not appear to be strong indicators of the actual ability to raise additional credit. Credit cannot compensate for a fundamental lack of income or a constant inability to meet expenses, especially for borrowers with damaged credit for whom high-cost banking products tend to be designed. Irresponsible loan products only put these consumers into a cycle of debt, exacerbating their situation and not improving their situation.
The Alliance of Online Lenders is a business group that contains many small lenders who operate online. Unsurprisingly, they are against the 36% rate cap, but they also have a lot in common with their counterparts at less than 36%, such as promoting partnerships between banks and fintech companies.
Many banks do not have the technical expertise to market, guarantee, create, manage and collect small loans and fill these gaps by partnering with a fintech company. Fintech companies have spent years developing innovative technologies and analyzes for these specific credit processes. A bank that partners with a FinTech company is able to use these technologies to reach consumers who otherwise might not be able to access credit, including borrowers, who live in what. these are called “bank deserts” where there are not many physical bank branches. .
This gives you an idea of some of the answers. The bottom line is that banks and fintech companies want to provide consumers with loan products that improve their financial situation. But how do you know if it helps? We have the credit score measure, but the problem is that many of the underserved people have poor or no credit records, so it would be difficult to measure the positive or negative impact of these loans.
There is no point in offering a loan that will end up being harmful to the consumer, I think there is general agreement between most parties on this point. But should we discourage the use of a product because it is harmful to certain consumers? This is not an easy question to answer. Perhaps a modernized CRA rule should take the results into account in determining whether or not a bank can accept CRA credit.
What we really need in this country is a framework to measure financial health. Organizations like CFSI are working there (they also have replied to the RFI) with their US Financial Health Pulse and other research. Perhaps one day in the distant future, every loan product will have a financial health rating so consumers can make more informed borrowing decisions.
Meanwhile, consumers continue to use payday loans in large numbers despite the fact that the results are mostly negative. If the banks offer small dollar loans, they will have to offer it widely to the people who currently use payday loans. Doing it in partnership with fintech companies is probably the best way to go, because in order to have any chance of making these loans profitable, you need to incorporate the very latest technology.
As the FDIC analyzes all of the responses, let’s hope they come up with a framework that encourages the responsible use of small dollar loans. Stay tuned on this.