As Online Financial Services Shift, Mainstream Institutions Join the Fray
The Consumer Financial Protection Bureau (CFPB) issued its long-anticipated small dollar rule earlier this month, a regulation that could eliminate 80% of the payday loan business. For the estimated 12 million people that regularly rely upon payday products, other financial service providers will need to step up and provide more responsible loan products and services to fill the massive credit void created by the small dollar rule.
Americans have traditionally sought out alternative financial services precisely because banks ignored the needs of consumers with less than perfect credit scores. But as the online marketplace for credit products grows, mainstream financial institutions and tech powerhouses are venturing into underserved communities and non-prime lending.
In 2008, the Federal Deposit Insurance Corporation (FDIC), a federal agency that provides deposit insurance to consumer bank accounts, conducted a one-year pilot program with 31 small banks across the United States. Few of the banks reported that the program was profitable, but many expressed the goodwill benefits it instilled in the community.
Aside from the pilot program, a few banks offered deposit advance products (DAP), a very short term loan that mimicked payday loans. The FDIC wrote of DAP in a 2013 press release that, “Deposit advance products share a number of characteristics seen in traditional payday loans, including high fees; short, lump-sum repayment terms; and inadequate attention to the consumer’s ability to repay. As such, banks need to be aware that deposit advance products can pose a variety of credit, reputational, operational, compliance and other risks.” Once the FDIC and the Office of the Comptroller of the Currency (OCC) issued guidance on the risks associated with DAP, virtually all American banks stopped offering DAPs. On the same day that the CFPB issued the small dollar rule, the OCC rescinded its guidance and concerns on DAPs, reopening bank customers more payday loan-type products.
Credit unions also offer a special form of non-prime credit called a payday alternative loan (PAL). PALs are part of a 2010 program and regulated by the National Credit Union Administration (NCUA). The loans typically max out at $1,000, cap at 28% APR, and are repaid within 6 months. Credit scores are seldom checked for these products. The biggest constraints on PALs are the limited memberships of credit unions. For those that do not live near or are not a customer of a credit union, PALs are not an option.
Traditional financial institutions are not the only businesses exploring short term, small dollar credit markets. Earlier this summer, online retail giant Amazon announced its intention to grow a small business lending program. The juggernaut retailer provided more than $1 billion to more than 20,000 merchants in 2016, helping retailers in its Amazon Marketplace expand inventory and offer competitive discounts on products. As banks struggle to provide needed capital to American small businesses, Amazon expands its portfolio of services and makes a name for itself in the credit world.
Paypal, the electronic wallet synonymous with online transactions, also provides small business loans to its merchants. The payment company recently acquired another small business lender, Swift Financial, to expand its presence in the marketplace. Similarly, JPMorgan just purchased an online payment company in an effort to keep pace with online lenders that can get funds to consumers and business owners in a matter of hours.
The ease at which online financial services can serve consumers has revolutionized consumer and small business credit and opened access to capital for millions of forgotten and underserved Americans.