What is short-term lending’s long-term future?
That’s the question on most segment watcher’s lips as 2017 gets up and running — and as millions nationwide await the final ruling from the CFPB.
If the rules pass as present, long-term might be something of a huge misnomer, since, by even the CFPB’s own in-house estimates, some 85 percent of the nation’s currently operating short-term lenders would be knocked out of business. And while some consumer advocacy groups would doubtlessly cheer that result as a great leap forward in protecting the underserved and disadvantaged from the so-called predators that roam the outskirts of the financial systems margins, the consumers they protect probably would have a very different reaction.
And a reaction that looks very much like panic as defined by overdraft fees, late fees, the inability to cover an emergency car repair, electricity shut downs and possibly even lost jobs. That’s because as the panel of experts assembled at Innovation Project 2017 last week at Harvard pointed out, the consumer who makes use of short-term lending:
- Likes them,
- Needs them and
- Has no other legitimate option available.
But unfortunately, the millions of consumers who like payday lending and use it responsibility won’t see their short-term debts disappear, even if the CFPB decides that 85 percent of their current solutions providers could disappear overnight.
So what comes next?
That was the question on deck for panel moderator and Principal at Continental Advisors, Paul Purcell, Advance America CEO, Patrick O’Shaughnessy, Enova EVP, Kirk Chartier and Illinois Secretary of the Department of Financial and Professional Regulation, Bryan Schneider, last week as they debated the future of short-term lending in the near and far term.
So how did that war gaming look?
Despite the fact that various members of the panel are short-term lenders — Advance America as the largest storefront lender and Enova as the largest online lender — no one made a case that abuses have not occurred within the industry, or that their sincere hope is to live in a regulation-free environment.
The problem — various panel members noted — is that various regulators, at times (and more recently, most of the time), seem to be caught in something of a time warp and are thus fully dedicated to regulating the worst excesses of the industry, circa the year 2010. Those regulations as currently proffered, they said, dictate the products on offer, which in turn limits the degree to which they can be innovated.
Which at the most basic level hurts customers, because the reality is that people who use short-term lending products actually need them. The reason these loans are taken out is to cover a bill that is due — or is about to be due — and for which there is no other legitimate alternative.
Which is one of the main problems with how regulators tend to view short-term lenders, various panel members observed. An interesting observation — and a keen insight — is that regulators tend to view the non-bank lender who underwrote the loan as being the creator of the debt. The short-term lender is just trying to help the lendee pay what they owe to a power company, auto mechanic, pharmacy or doctor.
And because regulators do not tend to think as much about the lendees — and what the loans are taken out for — they don’t tend to factor in things like installment loans (i.e. how the current batch of CFPB regulations would define all payday loans), which are not a one-size-fits-all solution for all consumers. They might work well for some groups of consumers. But for others, a smaller dollar amount that they can pay off in a single pay period or two is both more efficient and more manageable.
Moreover, one panel member noted, there’s something ironic about the CFPB putting “know your customer” requirements in place when they don’t seem to know very much about short-term lending customers. For example, the majority of borrowers don’t live in inner cities. Advance America CEO Patrick O’Shaughnessy noted that while his firm has many storefronts in the state of Illinois, they have exactly zero in the city of Chicago, inner or otherwise. The majority of borrowers are banked — since they need bank accounts in which to deposit the funds — and a surprising number also have credit cards.
The panel explained that the problem when viewing the “typical short-term lending customer” is that the typical picture is pretty varied. The loans are mostly situational tools used to solve a specific use case. But simply regulating them out of existence, one panel member opined, is a bit irresponsible.
“The CFPB rule is one where I don’t think it is well thought out, and it is a little offensive to the state system. My line on this rule is that it was written substantively by people who have never needed $500 to cover their costs or repair their car. So they prefer to severely limit credit opportunity for those folks and seem utterly unaware of the social consequence of that.”
In a world where the majority of short-term lending goes away, a possible future the panel pondered was one where the future of innovation is synonymous with the future of evasion — small dollar providers’ signature innovations will be around avoiding the reach of federal rules (by licensing offshore, or with Indian tribes or bouncing their servers all over the world).
That future, though, is a very limited one, agreed most panel members, since businesses whose sole focus is avoiding regulation usually aren’t so great at treating their customers all that well either. In the long term, that isn’t sustainable.
And by and large, the panel was pro-regulation, just absent those with apocalyptic actions like the CFPB ruling or Operation Chokepoint, which aren’t so much aimed at curbing abuse in payday lending as they are at simply stamping it out of existence.
The future they’d like to see is one with a more uniform set of expectations for short-term lenders — since the current system in the states was described at various times as an unpleasant patchwork of rules — and regulatory structure built around offering users more flexible products.
Which means that the market for short-term lending will also need to become a more data-rich environment. As various panel members pointed out, right now there is already sufficient access to data points about a consumer’s whole financial life — from bill payments to bank balances — that can give a lender a much finer ability to tailor their offerings.
Small dollar lending is a space that needs innovation — a subject that elicited no controversy on the panel. But those innovations will be hard won, because people remain suspicious of short term lending — for some legitimate reasons, and for some not so legitimate ones.
But consumers who use them need them. And as one panel member stated, it is naive to think banks and credit unions will simply jump in to fill this need should the current non-bank lender go away. Those institutions could, if they wanted, already be doing this kind of lending — but they’ve already decided to take a pass.
Which means someone is going to have to provide a tool for the consumer with a bank account living in the ‘burbs with an unexpected $500 car repair they needed to pay yesterday in order to drive to work tomorrow. And the question no one can answer yet is where that loan would come from, if short-term lending has no long-term future.