As long as nonbank small-dollar lending faces additional regulation and regulatory scrutiny, as we have previously discussed, the role of small-dollar loans made by traditional depository institutions should not be ignored.
To date, bank and credit union loans make up a tiny fraction of the small-dollar market, but that could change. This is a particular possibility if the nonbank portion of the market is negatively affected – through, for instance, lenders exiting the market or the enactment of laws further restricting the types of loans nonbanks can make – or if federal regulators incentivize their supervised institutions to make such loans, whether through positive Community Reinvestment Act (CRA) consideration or assurances that fair lending and other supervisory expectations can be satisfied.
The Federal Deposit Insurance Corporation (FDIC), for one, has actively encouraged its banks to make small-dollar loans to serve the “unbanked” and “underbanked” consumer segment that might otherwise use alternative financial services (AFS) such as nonbank payday loans, pawnbroker services, and check cashing. The FDIC has provided a forum for banks and credit unions to experiment in making small-dollar loans. In 2008, the FDIC began a two-year Small-Dollar Loan Pilot in which banks and credit unions volunteered to participate. The FDIC viewed the results of the pilot as a positive sign that banks and credit unions may be able to make such loans as a tool for bringing consumers into mainstream bank or credit union relationships:
“Since the pilot began, participating banks made more than 34,400 small-dollar loans with a principal balance of $40.2 million. Overall, small-dollar loan default rates were in line with default rates for similar types of unsecured loans. A key lesson learned was that most pilot bankers use small-dollar loan products as a cornerstone for building or retaining long-term banking relationships. In addition, long-term support from a bank’s board and senior management was cited as the most important element for programmatic success. Almost all of the pilot bankers indicated that small-dollar lending is a useful business strategy and that they will continue their small-dollar loan programs beyond the pilot.”
The Community Financial Services Association of America (CFSA), an organization representing the interests of lenders providing payday advances or other small, short-term loans, had a different take on the FDIC report, stating, “The report provides ample evidence that, while FDIC considers the program a success, small dollar loans from banks cannot compete with the cost and ease of payday loans.”
It is true that, to date, bank-based small-dollar lending has not supplanted its nonbank counterparts, for a number of possible reasons.
For one, banks may feel that regulatory challenges interfere with their ability to make small-dollar loans – challenges that are slightly different than those affecting nonbank lenders. For instance, banks must meet safety and soundness expectations in making any loan. To do so, they are expected to underwrite and price their loans appropriately according to risk. Even though banks are not subject to the same state interest rate limitations applicable to nonbank lenders, they may fear that they cannot price their small-dollar loans higher than other loans they make because they could be accused of differentiating pricing on a basis prohibited by fair lending laws. This could be an especially acute concern for banks new to small-dollar lending that do not have a track record of performance on these loans to inform their pricing. Banks may fear that their regulators will use fair-lending analysis methods that do not take into account the legitimate credit risk being accounted for in small-dollar loan pricing.
Such concerns could be assuaged if regulators provided concrete, updated guidance regarding ways that their supervised institutions could make small-dollar loans without inherently running afoul of fair lending requirements, or other compliance or safety and soundness requirements. The FDIC in particular has issued several communications that should provide some help to banks that want to make these loans, although they may stop short of what banks feel they need. For instance, the FDIC’s 2007 Affordable Small-Dollar Loan Guidelines, which “encourage financial institutions to offer small-dollar credit products and to promote these products to their customers,” state that such loans must be “consistent with all applicable federal and state laws,” but do not substantively address fair lending. In the FDIC’s Guidelines for Payday Lending, revised in 2015, the agency indicated that “[i]llegal discrimination may occur when a bank has both payday and other short-term lending programs that feature substantially different interest rate or pricing structures. Examiners should determine to whom the products are marketed, and how the rates or fees for each program are set, and whether there is evidence of potential discrimination.” If federal financial institution regulators – including the Federal Reserve, Office of the Comptroller of the Currency (OCC), and National Credit Union Administration (NCUA), as well as the FDIC – issued specific, concrete guidance stating in more detail that small-dollar lending would not inherently trigger undue fair lending scrutiny, and discussing concrete ways that such loans could be made while meeting compliance and safety and soundness expectations, financial institutions might be more inclined to make such loans.
Banks may also be incentivized to make small-dollar loans, even where not highly profitable, in order to meet the credit needs of their communities and thus to receive positive CRA consideration. (But loans deemed predatory, or unsafe or unsound, would not qualify for such consideration.) The 2007 FDIC guidance specifically addressed CRA in noting, “FDIC examiners may favorably consider small-dollar loan programs when evaluating the lending performance of small, intermediate-small, and large institutions. A small-dollar loan program may be viewed as uniquely responsive in helping to meet the credit needs of a community.”
And credit unions, as nonprofit entities chartered to serve their members (and which are not subject to the CRA), may also want to make small-dollar loans for the purpose of serving their members’ needs.
Thus, while there are a number of potential factors weighing for and against traditional depository institutions making small-dollar loans, presuming that banks and credit unions will remain on the small-dollar sidelines could amount to ignoring a potential source of competition for nonbanks. Along with many other issues affecting small-dollar lending, the future of bank- and credit union-based small-dollar lending is an area to watch.