Since 2021, nearly all of the 25 largest U.S. banks have substantially improved their overdraft policies. That’s good news for consumers. But because a third of bank customers who overdrafted viewed it as a way to borrow money, consumers would also benefit from banks starting to offer safe, small installment loans or lines of credit. More good news: As of early this year, six of the eight largest banks had done just that.
The following is an interview with Alex Horowitz, who has led The Pew Charitable Trusts’ small-dollar loans research since 2011.
How would you characterize a small installment loan from a bank?
Small loans from major banks generally go up to $500, $750, or $1,000, with minimum loan sizes ranging from $10 to $250. Some credit unions and community banks offer larger maximum loan sizes, such as $1,500 or $2,000. These bank and credit union products can be installment loans or lines of credit.
You talk about making these small installment loans safe. What do you mean by that?
What makes small loans safe for borrowers—and successful for banks—is adhering to a set of standards, which we at Pew have summarized as access, or reaching the bank’s existing customers who need financial help; speed, or providing credit quickly to meet customers’ needs; affordability, or keeping payments small by giving customers enough time—several months, typically—to repay; and fair pricing, or ensuring that loan costs are only a small fraction of the principal.
Weren’t banks already doing all of that?
No, not for customers with poor or no credit scores. Even though 95.5% of U.S. households have a checking account, millions are underbanked, meaning that while they’re bank or credit union customers, when they need to borrow, they go outside the banking system to payday, auto title, pawn, rent-to-own, or other high-cost lenders.
Remind us, what’s the problem with payday loans?
Payday loans have unrealistic terms, excessive costs, and unaffordable payments. They’re marketed as two-week products, but the average borrower ends up in debt for five months, spending $520 in fees to repeatedly borrow $375. To get a payday loan, borrowers give the lender direct access to their checking accounts, electronically or with a postdated check. So everyone who uses these loans has an income and is already a bank or credit union customer with a checking account.
What changes have led banks to offer lower-cost small loans?
Regulators, lawmakers, and consumer advocates have been urging banks to change their extremely expensive overdraft practices for some time—for good reason. That helped create space for banks to re-evaluate the products they offer consumers who are struggling to make ends meet. The landscape shifted dramatically in 2020 when the federal bank and credit union regulators issued joint guidance that enabled banks to start lending small amounts to customers—even people with poor or no credit histories—using automated underwriting techniques. Within a few years, six of the eight largest banks, which operate about a quarter of all branches in the U.S., launched responsible small installment loans or lines of credit that cost consumers at least 15 times less than average payday loans. Numerous smaller banks and credit unions have also begun offering similar products, spurred by developments in financial technology and competition from digital-only providers.
Why is it a good thing that banks are offering these small installment loans?
Each year, millions of people borrow small sums to make ends meet, spending more than $20 billion at high-cost, nonbank lenders. Usually, those borrowers have a checking account but lacked access to small loans from their bank; banks were primarily offering larger loans to borrowers with better credit scores. But now that banks and credit unions have created affordable small credit options that are faster than payday loans, borrowers can save hundreds of dollars each—adding up to billions of dollars annually. As more banks and credit unions provide similar loans to customers with damaged or no credit histories, millions of consumers will benefit.
What about the loans’ safety?
Our research has found that the loans from the largest banks meet standards of safety and affordability. Their strong consumer protections make them far safer than nonbank products.
How have people reacted to bank loans that meet Pew’s standards of access, speed, affordability, and fair pricing?
Four in 5 payday loan customers said they would prefer to borrow from their banks. Similarly, 7 in 8 adults favor banks offering small loans. These new loans are being well received: Bank regulators cited the increase in bank small-dollar lending as a top-10 achievement in 2020, the year they issued their joint guidance. Syndicated editorials have praised the introduction of the loans, with one saying “[i]t’s about time a corporate bank found a way to challenge predatory payday lenders.” And consumer advocates have emphasized the “strong consumer protections with these loans” and the potential to “be a really viable option for a lot of people.”
What’s the path to success for banks and credit unions when offering small loans?
For most banks and credit unions, success in the small-dollar loan market requires a high degree of automation, from underwriting and loan origination to funds disbursal and repayment. That’s because customers are looking for money to meet an urgent expense, so they’re prioritizing speed, ease of access, and likelihood of approval—areas where payday lenders excel.
Banks and credit unions need to be able to meet those consumer needs, too. That’s where automation comes in.
It helps in all these areas: speed, ease of use, and likelihood of approval. And it can save banks money, too. Here’s just one example: Automation lets a lender pre-screen customers so only those who qualify will receive offers. That helps keep costs and staff time as close to zero as possible, which in turn keeps the cost to the borrower low.
Are banks ready to take on the required level of automation?
Generally, yes. Some large banks have developed, or are developing, their own automated systems, but most small and midsized institutions use technology vendors to help them.
So if banks and credit unions keep entering the small-loan market in increasing numbers, does that mean that payday loans go away?
No. Banks are beginning to put a sizable dent in the market for payday loans and other nonbank credit. But only state policymakers have the power to fully protect consumers from harmful payday loan terms.
In any case, it sounds like the small-dollar loan market is moving in the right direction for consumers. Could it still go sideways?
Several years ago, we at Pew warned that regulators and banks must stay vigilant to promote safe small installment loans and reject harmful practices—such as loans that require balloon payments. So far, so good.
But in just one example of how things could go wrong, a few small banks have formed harmful “rent-a-bank” partnerships with payday lenders to lend to people who don’t even have a checking account with the bank. These “bank” loans sometimes cost more than actual payday loans, and they generate losses exceeding 50%. Rent-a-bank loans are an aberration and should not be welcome in the banking system.
Overall, though, the future looks bright—as long as banks and credit unions lend to their own checking account customers and follow sensible standards and joint guidance from their regulators. That’s what most of the largest banks have done so far. And that’s what all banks and credit unions should do.
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