As the scale of the economic fallout from the coronavirus pandemic became clear, five federal financial regulatory agencies in late March took the unusual step of issuing a joint statement encouraging banks and credit unions to offer emergency small loans to struggling consumers. The statement could be a positive development for Americans facing increased hardship, but it may also encourage banks and credit unions to offer some potentially harmful loan products. The regulators can protect consumers both in this time of heightened economic vulnerability and over the long term by issuing clear guidance and strong, data-driven small-lending standards, such as those outlined in our research, for traditional financial institutions.
To date, only one of the top 10 banks, U.S. Bank, makes such loans widely available to customers; the bank launched a small installment loan, repayable over three months, in 2018 after the Office of the Comptroller of the Currency (OCC) issued clear, well-designed small-loan guidelines. Although other federal regulators have yet to endorse the OCC’s 2018 guidelines, the latest statement may be a step in the right direction.
Extensive research from The Pew Charitable Trusts has shown that banks can deliver significant savings to consumers by offering small installment loans and lines of credit at much lower prices than the high-cost, unaffordable loans their customers can access from nonbank providers such as payday, auto title, and similar lenders. With clear guidance from regulators, banks would be able to profitably charge consumers six to eight times less than payday lenders do for the same size loans. (See Table 1.) According to national polling, 8 in 10 payday borrowers would prefer to get a loan from their bank or credit union if they were equally likely to be approved.
Typical cost of $400 borrowed over 3 months, by lender
|Sustainable bank installment loan||“Deposit advance” loans (no longer available)||Pawn loans||Eight $35 overdraft fees||Auto title loans||Payday loans|
Source: The Pew Charitable Trusts, “Comment Letter Regarding FDIC Request for Information on Small-Dollar Lending, RIN 3064-Za04” (2019), https://www.fdic.gov/regulations/laws/federal/2018/2018-small-dollar-lending-3064-za04-c-015.pdf
The rare joint statement from the federal agencies makes clear that consensus is growing among regulators that bank-issued alternatives to high-cost loans have a role to play both in the coronavirus response and in serving small-dollar borrowers over the long term. However, consumer advocates have expressed legitimate concerns that regulators may be opening the door to harmful products from banks, particularly what the statement referred to as “appropriately structured single payment loans.” The OCC and Federal Deposit Insurance Corp. had previously clamped down on single-payment “deposit advance” products from banks that typically carried annual percentage rates (APRs) of 200% to 300%. These harmful bank-issued payday loans consumed an average of 27% of a borrower’s next paycheck, triggering frequent reborrowing: The median borrower used these loans for eight pay periods a year, while the typical heavy borrower took single-payment loans during 19 separate pay periods, or more than two-thirds of the year.
To help ensure that widely available small loans from banks and credit unions are sustainable and safe, Pew has published recommended lending standards (see Table 2) based on extensive consumer research and more than 100 discussions with bank and credit union executives.
Pew’s recommended small lending standards
|Affordable payments||Loans should feature automated underwriting and limit payments to a small, affordable share of a borrower’s paycheck, such as 5% of income.
|Fair prices||To be viable for lenders, small loans need rates that are higher than those on credit cards, but three-digit APRs are not appropriate. Payday loan borrowers and the general public agree that charging $35 for a three-month, $300 loan is fair. Such prices are six to eight times lower than typical payday loans and would save consumers billions of dollars annually.
|Reasonable time to repay||Borrowers need more than one pay period to repay, especially because people using these loans are in financial distress. The OCC appropriately recognized this need in its 2018 guidance, stating that loans should last longer than 45 days.
|No overdraft||Payments on small loans from banks should never trigger overdraft fees. Harmful overdraft fees drive struggling consumers out of the banking system.
|Credit building features||Successful repayment should be reported to credit bureaus to help borrowers improve their credit scores.
Source: The Pew Charitable Trusts, “Standards Needed for Safe Small Installment Loans From Banks, Credit Unions” (2018), https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2018/02/standards-needed-for-safe-small-installment-loans-from-banks-credit-unions
Notably, federal regulators also signaled that they are working on longer-term guidance for bank-issued small loans. If designed appropriately, with a minimum term of 45 days and simple automated underwriting standards similar to those described in the OCC’s 2018 bulletin, that direction could result in a large expansion of affordable installment credit from banks and save consumers billions of dollars annually. As the coronavirus outbreak has made plain, a large share of Americans have little financial margin for error. Small installment loans from banks can help see them through tough times.
Nick Bourke is a director and Gabriel Kravitz is an officer with The Pew Charitable Trusts’ consumer finance project.