Why The New Short-Term Lending Rules Keep Banks Sidelined

“The most important number to keep in mind here is 12 million. A lot of numbers are getting thrown around in this debate, but 12 million is the one to watch because that is the number of Americans seeking small-dollar loans each year.”

Around 12 million Americans seek payday loans every year. The majority of borrowers are single, white women with children. Most have a full-time job, a statistically significant proportion have more than one full-time job and the average annual income of a payday borrower tends to range between $25,000 and $40,000 per year (per household). All borrowers have active checking accounts — these are not products for the unbanked — and on average, the amount sought is a shade less than $400 ($387). The sum in question is almost always dedicated to paying off a bill.

Short-term borrowers are not exactly who people tend to think they are, and as it turns out, they aren’t that different from the vast mainstream of American consumers. Recent data from the Federal Reserve Board indicates that 47 percent of Americans would have significant difficulty paying an unexpected $400 bill, and as Neal Gabler’s recent article in The Atlantic demonstrates, an awful lot of those 47 percent are people who would appear from the outside to be members of the prosperous middle class.

And this is the fundamental problem with the latest round of short-term lending rules by the CFPB: They fundamentally lose sight of those 12 million consumers, according to the CBA.

“Do these new rules provide any reasonable alternative for those 12 million consumers as they are written? In our opinion, they do not. Banks remains frozen out of this market and, in fact, are now less able to participate than ever,” one CBA member told PYMNTS.

And the CBA is not alone in the position; Pew Charitable Trusts sort of agrees.

“The CFPB is missing a big opportunity to encourage safer and more affordable loan options,” Pew’s short-term loans project director, Nick Bourke, told PYMNTS last week when the rules dropped. “The new proposal lets 400 percent APR loans flourish but locks out lower-cost loans from banks.”

On the lockout point, the CBA and Pew agree, though they go on to disagree about what they think would be a reasonable accommodation.

Pew would like to see a set of very rigorous guidelines for bank small-dollar lenders built around a 5 percent cap. That means that borrowers could not be charged more than 5 percent of their paycheck for a loan repayment period of no more than six months.

The CBA thinks that plan is likely unworkable because it shares a rather central defect with the CFPB’s regulations: It would require underwriting standards that essentially don’t make sense.

“The problem with plans that force lenders to take a long, evaluative look at small-dollar borrowers is that it essentially forces banks to treat a $300 dollar loan like a $300,000 mortgage. It just doesn’t make sense.”

“These plans will all require manual underwriting for short-term loans, which would make small-dollar products cost-prohibitive for banks.”

And more importantly, the CBA argues, there has already been a completely workable bank-based alternative to small-dollar loans in the form of deposit advance products that the CFPB has essentially ruled out with its new regulations.

While the CPPB and others have tended to group deposit advance products with payday loans as essentially the same product under two names, the CBA contends that they are demonstrably different. Deposit advance products are taken from banks with which clients have an established relationship, as opposed to third-party lenders that they essentially meet on the day they take out the loan. Bank-based products also don’t require third-party access to consumers’ bank accounts, almost never end in an escalating string of overdraft fees and account closures and already come “out of the box” with internal controls limiting how much and how often customers can borrow.

And though controls make sense and banks have an immense incentive to offer them, the goal after all is not to lose money in lending but to actually get paid back. What the CFPB is proposing would simply make the products both too expensive for banks to create and too limited for consumers to want to use.

Of particular concern are the mandatory requirements that consumers can only take short-term loans out six times a year and be in debt for no more than 90 days. This requirement might seem a little peculiar given that most short-term lending clients use the loans to pay bills. It is not clear what happens under these rules to the consumer that has three bad things happen in the same year or a customer who needs to be in debt for 120 days?

Which means the question comes down to those 12 million consumers and what happens if 65 to 85 percent of short-term lenders go out of business.

Banks can’t pick up that slack, according to the CBA, as they’ve been given no guidance from the CFPB as to how they might offer a cost-effective, useful product. But they’ve been given lots of guidance by the FDIC and the OCC that deposit advance products were no longer allowed, unless banks were willing to underwrite small-dollar loans with the same strictness they underwrote mortgages. Banks demurred and have been sitting on the sidelines since 2013.

And on the sidelines it looks like they will stay, unless the CBA can prevail upon the CFPB to liberalize those new payday lending rules some.

If it doesn’t, well, 12 million consumers looking to pay bills are going to go somewhere. Whether where they go is sanely and sensibly regulated or run outside the reach of the CFPB’s rules, offshore or on a tribal land, remains to be seen.