Banks Are Not the Solution to Responsible Small Dollar Credit

Earlier this month, Pew Charitable Trusts, an organization founded on religious conviction and oil profits, published a report advocating for an increased presence from banks and credit unions in alternative financial services, particularly small dollar lending. The report heralded these traditional financial institutions for their advanced automation and familiarity with consumers through account holdings. Pew noted that banks benefit from low costs of capital and overhead costs split between multiple loan products and services.

Many of the report’s recommendations focus on limiting loan terms based on a borrower’s ability to repay, similar to a rule governing small dollar loans recently published by the Consumer Financial Protection Bureau (CFPB). For a non-profit that promotes a goal of “inform[ing] the public by providing useful data,” Pew’s report is uncharacteristically light on rigorous data analysis to back its claims.

First, in advocating for lower interest rates on small dollar products, the report claims that banks could profitably offer $375 over 5 months for only $100 in interest and fees. The report cites no source to back this assertion.

Little data exists on bank and credit union penetration into small dollar lending, typically categorized as loans of less than $1,000. The most comprehensive study to date was performed through a pilot program 10 years ago by the Federal Deposit Insurance Corporation (FDIC). The FDIC’s Small Dollar Loan Pilot Program enlisted 31 small and community banks with the challenge of offering small dollar loan products with a total annual percentage rate (APR) of 36% or less. Over the course of two years, nearly 15,000 loans were provided at a principal value of $40.2 million. The average loan was $700 with a repayment period of 10 to 12 months.

The profitability of the loans in the FDIC pilot program was muted. The program was eventually expanded to near small dollar loans (between $1,000-$2,500) because the banks could profit from them more easily. Most banks approached the program as a loss-leader, a marketing term for products sold at a loss to attract customers. Banks saw small dollar loans as a way to establish new relationships or maintain their existing customer base. Since origination costs and other overhead was similar for small dollar loans and other conventional products offered by the banks, an incredibly high volume of small dollar loans would likely be needed to maintain any form of viability.

Beyond the viability of small dollar loans under Pew’s recommended standards, there is no evidence that banks would even want to lend under Pew’s restrictions. In 2016 when the CFPB was writing the Small Dollar Rule, Rick Metzger, the chairman of the National Credit Union Administration, a fellow federal regulatory body, encouraged the CFPB to exempt payday alternative loans (PALs) from the proposed rule. The final rule provided by the CFPB did permit credit unions and community banks waivers from certain standards in the rule for small dollar loans, but restricted the exemptions to very low volumes.

The American Bankers Association (ABA) issued its own report last summer on the feasibility and desire for banks to offer small dollar loans. However to achieve entrance into the small dollar credit market, the ABA recommended that the federal government essentially remove all of the regulatory protections originally legislated in the first place. These barriers include a credit card rule that prevents banks from unilaterally and unforgivingly raising rates on customers, requirements that a consumer demonstrate their ability to repay prior to issuance of a loan, and agency guidance that forces banks to comply with credit risk standards when making Direct Deposit Advances to account holders. Total industry deregulation is a far cry from Pew’s proposed standards.

Millions of Americans rely on alternative financial services because of banks’ inability to supply the credit needs of consumers. In 1977, Congress attempted to improve credit access for low and middle income families with the passage of the Community Reinvestment Act (CRA). Under the CRA, banks would now need to expand credit offerings to underserved populations. Unfortunately, the CRA provides little incentive to expand credit and few punishment methods for those that ignore it. Despite federal legislation, banks continue to abandon low and middle income neighborhoods at an alarming rate.

Pew concludes its report by noting, “Numerous banks and credit unions are interested in offering small loans with the consumer-friendly characteristics laid out in this brief.” Unfortunately, Pew does not appear to have the data or support from industry trade organizations and regulators to back this assertion.