Former head of the Federal Deposit Insurance Corporation Sheila Bair this week urged banks to use their existing infrastructure and customer base to bring competition to the so-called payday lending industry. She argued that this could benefit both banks, through a profitable new business line, and consumers, who currently face annualized interest rates approaching 400 percent when they borrow from storefront payday lenders.
Writing for Fortune magazine, she said Federal regulators were correct when they recently pushed banks to get out of the business of offering “deposit advance” loans. These products were marketed to existing checking account holders who were paid via direct deposit. Banks would advance the sum being borrowed and then debit the account for the amount borrowed plus interest on the customer’s next payday.
Deposit advance loans still cost customers an average 261 percent in annualized interest costs, Bair wrote, and the requirement that they be paid back in a lump sum often forced customers into a cycle of debt that was difficult to escape. The Office of the Comptroller of the Currency and the FDIC issued guidance to banks that indicated they did not see the product as consistent with safe and sound banking practices.
“Now that banks have been duly chastised by their regulators,” Bair wrote, “I hope they will go back to the drawing board and develop a payday loan that while profitable to them, is also affordable to borrowers without having to engage in serial re-borrowings.”
Nick Bourke, director of the Small-Dollar Loan Project at the Pew Charitable Trusts, where Bair is a senior advisor, said that research by his organization shows that small-dollar loans can be made profitably and without causing long-term financial harm to borrowers, so long as the conditions are right.
“There is a need for creating some good guidelines that will help competition to flourish,” he said. And banks are far better positioned to compete in the payday loan space than storefront operations will ever be.
The storefront payday lending operation is extremely inefficient, he explained. According to a recent Pew study the average provider makes 10 to 13 loans each day and serves only about 500 individual customers per year.
The result, he said, is that “the key cost driver of payday loans is overhead not credit losses.” Pew found that for storefront payday lenders, overhead costs represent 64 percent of expenses, as opposed to credit losses, which only account for 17 percent.
Because of their existing infrastructure and customer base, Bourke said, “Banks can offer these products for much lower rates. Banks are really well positioned. It is a lot cheaper for a bank to offer new types of loan products, to collect on them, and to manage their costs.”
Bourke said that recent research by Pew has found that the key to limiting credit losses is a system that allows customers to repay their loans over time, and that limits each individual payment to 5 percent or less of the borrower’s income.
This gives banks another advantage over storefront lenders, because they have the ability to automate regular payments from the borrower, making it possible to allow repayment over time rather than requiring the lump sum repayment that often forces a borrower into taking another loan.
Payday lenders, by contrast, who often repay themselves by cashing a pre-signed check or making a single automatic debit from a customer’s account, generally don’t have the infrastructure in place to offer payment over time efficiently.
To be sure, even if banks get into the payday loan business, Bourke says there are no illusions about rates dropping very far. This is still a high-risk market, and banks price loans based primarily on the danger of not being repaid. But Pew believes that banks could profitably offer loans with annualized interest rates of between 36 percent and 100 percent.
Still high, yes. But for borrowers in need of cash, it’s an attractive alternative to 400 percent interest rates and a never-ending cycle of debt. - Follow Rob Garver on Twitter @rrgarver
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