A recent story in American Banker reported that at least three banks are planning to launch new low-value loan products after the Consumer Financial Protection Bureau’s payday loan rule takes effect. The article says banks are attracted to a possible CFPB exemption from underwriting requirements for loans meeting certain characteristics. Here is why I doubt this development.
The return of banks to the low-value short-term credit market would be an advantage for consumer choice. Additional competition drives innovation, which improves products and services and reduces costs. Payday lenders represented by the Community Financial Services Association of America have always welcomed more competition, as we noted in these pages previously.
However, I am quite skeptical that the CFPB rule changes banks’ resistance to these products. So far, the big banks have lost interest in serving this market and the products they have tried to offer have not been successful. If the banks could profitably serve this market, why aren’t they already doing so?
A recent study commissioned by the American Bankers Association found that only 1% of banks surveyed currently offer loans of $ 500 or less. Banks largely find loans of a few hundred dollars unprofitable and unsustainable due to the high cost and risk of offering these products. In fact, in 2009, the FDIC’s Small Dollar Loans Pilot Program enabled banks to offer payday loan-type products with an interest rate cap of 36%. But these products proved to be unprofitable short term.
Even if more banks would offer low-value loans under the CFPB rule, the recent American Banker article indicates that banks would only clean up $ 70 on a $ 500 loan, roughly double the average cost of loans. overdraft fees. This revenue is simply not enough to offset the increased costs associated with offering products at low prices. Staff costs and real estate costs – the main factors in the cost of a payday loan – are much higher on a unit basis for banks.
The article stated that loan products attracting interest from banks would have monthly payments limited to 5% of borrowers’ income, as this is the threshold exempting loans from CFPB underwriting requirements. The 5% threshold superficially seems like a good idea; this would certainly ensure that these loans are affordable for today’s most creditworthy borrowers. However, the 5% limit will serve to exclude the vast majority of current borrowers as they would not be able to claim the amount of credit they need for this test. The Pew Charitable Trusts developed the 5% test from anecdotes from focus group participants, and there is no empirical support for the idea that imposing such a standard – at 5% or at any other level – would improve the welfare of borrowers.
The CFPB proposal, which in its current form would drive non-bank lenders out of the market, creates a convenient entrance for traditional banks, but at the same time leaves millions of customers without access to short-term credit. Many consumers who use payday loans are unable to borrow from banks. Some choose to consult with non-bank lenders because they are uncomfortable with banks or find them uncomfortable, while others live in areas that are not served by banks.
If the banks could really serve these customers profitably, they would stay in these neighborhoods. Instead, they wrote off those areas as poor prospects where consumers tend to keep account balances small and are unlikely to turn to more profitable banking products.
One executive cited in the article attempts to justify the lower profit margin of short-term credit products as a gateway to future transactions. However, what will happen if these transactions do not materialize at the levels the banks want? The ‘premium’ check cashing, money transfer, remittance and other services demanded by these customers are incompatible with current retail banking models that rely on streamlined and self-service. electronic transactions. The numbers just won’t add up for the banks.
If Pew and other critics are successful, the CFPB’s proposals will lead to around 82% reduction in payday loan income for small lenders. I have valued that 60% or more of payday lenders could close their doors. Some clients of these lenders will turn to banks, if they have the opportunity. However, banks are much more likely to acquire a very small number of the most qualified borrowers and leave less creditworthy applicants with no options, forcing many to turn to illegal online lenders and loan sharks.
Regulators and advocacy groups should keep these thoughts in mind before crafting a rule that favors the needs of banks over the needs of the consumers advocates claim to represent.
Dennis Shaul is the CEO of the Community Financial Services Association of America, which represents non-bank lenders. He previously served as a senior advisor to former Rep. Barney Frank and a professional member of the House Financial Services Committee.