Consumers who rely on payday loans to fill their budget gaps may have a new option to turn to: traditional banks.
National banks last month received the go-ahead to serve that market from their regulator, the Office of the Comptroller of the Currency. Comptroller of the Currency Joseph Otting called for national banks and federal savings associations to step into the short-term, small-dollar installment loan market.
These loans typically range from $300 to $5,000, and that adds up to about $90 billion in loans taken out every year by millions of U.S. consumers. "Consumers should have more choices that are safe and affordable, and banks should be part of that solution," Otting said in a statement.
Letting banks offer these kinds of loans will give more choice to consumers, who often turn to payday loans to make up for personal money shortages.
"The OCC announcement gives banks the regulatory certainty they needed to offer small loans," said Alex Horowitz, senior research officer for the consumer finance project at Pew Charitable Trusts. "That's a big deal."
Unlike payday loans, which are typically due all at once with the next pay check, short-term, small-dollar loans would give consumers two to 12 months to pay off their balance over several installments, according to Horowitz.
Short-term loans generally also come with a two-digit annual percentage rate, versus the three-digit APR that payday loans typically demand.
"This is good news for consumers," Horowitz said. "For a typical payday loan borrower, using a loan like this from a bank would save them hundreds of dollars a year."
The OCC's go ahead is a key development following authorization the Consumer Financial Protection Bureau gave banks and credit unions to provide these loans last October. The CFPB's green light also came with a condition - that consumers would have at least 45 days to repay the loans.
Financial institutions needed approval from their respective regulators - one of which was the OCC - in order to follow up on the CFPB's move.
The OCC primarily oversees large banks. That means that other financial institutions that want to get into this lending, such as regional banks, small banks and credit unions, would need approval from their respective regulators, including the Federal Reserve, the Federal Deposit Insurance Corporation and the National Credit Union Administration.
Last month, the National Credit Union Administration proposed a new rule to loosen some of the regulations on small-dollar loan programs, which would make it easier for credit unions to offer these loans, Horowitz said.
The FDIC could also opt to re-evaluate the rules for offering these kinds of loans for the small banks it regulates once it comes under new leadership.
Another proposal for making payday loan-type lending more mainstream was put forth by Sen. Kirsten Gillibrand, D-N.Y., in April. Gillibrand proposed that the Postal Service could start offering retail banking services including small-dollar loans with low fees and interest rates.
Otting's statement acknowledges that banks may not be able to serve all of this large market.
Some industry experts question whether operating in the small-loan space will be profitable enough for banks.
"Banks in the past have tried to offer these loans and found them unprofitable," Dennis Shaul, CEO of the Community Financial Services Association of America, said in a statement. "In 2009, for example, the FDIC tested a small-dollar loan pilot program to explore the viability of banks offering small-dollar loans. Banks stopped offering these loans because they were unsustainable."
But banks could profitably operate in this space if they leverage technology advancements that have happened in the past decade, Horowitz said.
That would mean using automated underwriting, or an algorithm to determine a borrower's eligibility and provide an immediate decision, versus having an employee of a bank to make that decision. Banks would also need to originate those loans either through online or mobile banking.
The demand for those loans from banks on the consumer side is there, Horowitz said. Of 826 payday loan borrowers that Pew surveyed, 81% said they would prefer to borrow from a bank or credit union over a payday lender.
New research released by consumer credit reporting company TransUnion backs the idea that traditional lenders can find suitable loan candidates among this population.
TransUnion analyzed consumer activity in its alternative lending database including short-term and installment loans.
Its research found that there is a significant population of these borrowers who are not subprime, those who come with the highest lending risk.
"There's a perception out there that they're all either unbanked or deep subprime, and that's not true," said Elizabeth Pagel, vice president of market strategy and consumer lending at TransUnion. "There's a lot of diversity in that population."
The OCC argues that if banks offer these short-term loans to consumers with low credit scores, it can help to bring them into mainstream banking and avoid getting trapped under high debts.
Despite low credit scores, other factors - such as the length of time a customer has been with a bank and the regularity with which they make deposits into their accounts - can make them good short-term loan candidates, Horowitz said.
"They're probably a strong candidate to repay the loan because they are showing stability and they are showing a relationship with the bank," Horowitz said. "The fact that they have a low credit score shouldn't disqualify them from being able to borrow."
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