Federal bank regulators encourage small loans in response to COVID-19

As the magnitude of the economic fallout from the coronavirus pandemic became clear, five federal financial regulatory agencies ended March with the unusual measure of publish a joint statement encourage banks and credit unions to offer small emergency loans to consumers in difficulty. The statement could be a positive development for Americans facing increased hardship, but it could also encourage banks and credit unions to come up with potentially dangerous loan products. Regulators can protect consumers both in this time of heightened economic vulnerability and in the long run by issuing clear guidance and strong, evidence-based small loan standards, such as those outlined in our research, for financial institutions. traditional.

To date, only one of the top 10 banks, US Bank, offers such loans to its 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 and well-designed guidelines for small loans. While other federal regulators have yet to approve the OCC’s 2018 guidelines, the latest statement could be a step in the right direction.

Extensive research by The Pew Charitable Trusts has shown that banks can provide consumers with substantial savings by offering small installment loans and lines of credit at prices well below the expensive and unaffordable loans that their customers can access. from non-bank providers such as payday, auto title and similar lenders. With clear guidance from regulators, banks would be able to cost-effectively charge consumers six to eight times less than payday lenders for similar-sized loans. (See Table 1.) According to a national survey, 8 in 10 payday borrowers would prefer a loan from their bank or credit union if they were also likely to be approved.

Table 1

Banks can offer small loans at much lower costs than non-bank sources

Typical cost of $ 400 borrowed over 3 months, per lender

Durable installment bank loan “Advance on surety” loans (no longer available) Pawnbrokers Eight overdraft fees of $ 35 Auto title loans Payday loans
$ 48-60 $ 240 $ 240 $ 280 $ 300 $ 360

Source: The Pew Charitable Trusts, “Comment Letter Regarding FDIC’s Request for Information on Low Cost Loans, 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 federal agencies makes it clear that consensus is growing among regulators that banking alternatives to high-cost loans have a role to play in both the coronavirus response and in serving small borrowers at long term. However, consumer advocates have Express legitimate concerns that regulators could open the door to harmful bank products, particularly what the statement calls “appropriately structured single payment loans”. The OCC and the Federal Deposit Insurance Corp. previously cracked down on one-time payment “deposit advance” products from banks that typically charged annual percentage rates (APRs) of 200% to 300%. These harmful bank payday loans consumed an average of 27% of a borrower’s next paycheck, causing frequent borrow again: The median borrower used these loans for eight pay periods per year, while the typical heavy borrower took out lump sum loans for 19 separate pay periods, or more than two-thirds of the year.

To help ensure that the small loans widely available from banks and credit unions are durable and secure, Pew has published Recommended Lending Standards (see Table 2) based on extensive consumer research and more 100 discussions with leaders of banks and credit unions.

Table 2

Small loans from banks should include strong collateral

Pew Recommended Small Loan Standards

Basic protections Explanation
Affordable payments Loans should have automated underwriting and limit payments to an affordable small portion of a borrower’s salary, such as 5% of income.
Fair prices To be viable for lenders, small loans require higher rates than credit cards, but triple-digit APRs are not appropriate. Payday loan borrowers and the general public agree that it’s fair to charge $ 35 for a three-month $ 300 loan. These prices are six to eight times lower than typical payday loans and would save consumers billions of dollars each year.
Reasonable time to reimburse Borrowers need more than one pay period to repay, especially because the people who use these loans are in financial difficulty. The OCC rightly recognized this need in its 2018 guidelines, indicating that loans should last longer than 45 days.
No overdraft Payments on small bank loans should never incur overdraft fees. Harmful overdraft fees drive troubled consumers out of the banking system.
Credit construction features A successful repayment should be reported to the credit bureaus to help borrowers improve their credit rating.

Source: The Pew Charitable Trusts, “Standards Required for Safe Small Loans from Banks and 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 have also signaled that they are working on longer-term guidance for small loans issued by banks. If designed appropriately, with a minimum duration of 45 days and simple automated underwriting standards similar to those described in OCCs Bulletin 2018, this direction could lead to a wide expansion of affordable installment credit from banks and save consumers billions of dollars every year. As the coronavirus epidemic has clearly shown, a large portion of Americans have little room for financial error. Small installment loans from banks can help them get through tough times.

Nick Bourke is a director and Gabriel Kravitz is responsible for the consumer finance project of The Pew Charitable Trusts.

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