What Will Replace Payday Lending?

In this month's the Atlantic, Bethany McLean examines "fringe financial services" and their customers, asking what will happen to the more than one in six Americans who rely on these services once the Consumer Financial Protection Bureau regulates them out of existence. Read the full story here.

The alternatives, McLean finds, fall short. Banks already make too much money from overdraft programs to introduce a more affordable competitor. Credit unions "struggle with regulators, with reputational risk, and with the cost of making such loans." Postal banking is "unfeasible." Online lenders are "difficult to police" and their rates are "higher, not lower, than those charged by traditional lenders."

As McLean poses, what will come after payday lending?

A recent report in American Banker seemingly offers a glimpse. Three banks have reportedly showed interest in offering short-term, small-dollar loans under the Bureau's requirement that loan payments do not constitute more than five percent of a consumer's monthly income.

Scant details aside, this effort is a hasty attempt to introduce a so-called "mainstream" financial product into the marketplace to sidestep questions that no alternatives to traditional payday lending exist. Banks and credit unions have called for strong short-term lending rules but only if, as the National Association of Federal Credit Unions wrote to the Bureau, the rules "include an express exemption for federal credit unions and other insured depository institutions." A number of banks dropped their previous payday loan alternative, the deposit advance, following strict guidance from the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC).

These institutions understand how onerous the CFPB's outlined regulations are and instead hope to clear the field for their own competing short-term loan products. But banks and credit unions offering payday alternatives would likely run into four issues that have plagued previous alternatives: flexibility, access, scale and consumer preferences.

Flexibility. While non-bank lenders already offer longer term loans, many consumers still prefer the two-week payday loan to manage their finances. These borrowers value the flexibility, simplicity, and ease of the two-week loan. In fact, more than a fourth of Advance America customers in Colorado (which requires longer pay periods) pay off their six-month loan early, in essence, to turn the loan into a traditional payday product.

Access. Banks come with rigorous account requirements. Will borrowers be able to access their funds on the same day? Will only consumers with bank accounts have access to the programs? More significantly, under the Bureau's current proposal, borrowers could only use this service twice a year. It is unrealistic to assume borrowers will only need credit once every six months, and dangerous to restrict how often they can access that credit.

Scale. Banks continue to retreat from low income neighborhoods - a recent FDIC study found that low income Americans are now 80 percent more likely to live in a banking desert than their higher income counterparts. Can these bank branches serve the needs of the more than 18 million Americans that use short-term credit?

Consumer preferences. Many borrowers have previously been burned by banks' hidden fees, confusing terms and unfriendly (or non-existent) customer service. Professor Lisa Servon, for example, found that these consumers have "made a conscious choice to be unbanked," preferring "alternative financial service providers where the personal relationships between the teller and the customer still matter tremendously." Even with lower rates, many consumers will still prefer non-bank lenders.

That final point - that consumers prefer short-term lenders for a variety of reasons - is still overlooked or rejected by consumer activists and Bureau officials. According to a recent survey of consumers who have borrowed from a payday lender, nearly all (96 percent) believe payday loans have been useful to them personally and 72 percent say they received better treatment from their payday lender than from a bank or credit card company.

Regulated short-term lenders already provide the flexibility, access and scale needed to serve Americans financial needs, and consumers appreciate that lenders place customer service at the center of their business. While incremental reforms addressing illegal and bad actors in the marketplace will help consumers, wholesale reform - like those the Bureau proposes - will undoubtedly leave them worse off.

P.S. CFSA on Banks Short-term Lending Plans

Community Financial Services Association CEO Dennis Shaul outlines in American Banker why, despite rumblings that depository institutions are exploring small-dollar loan products, the "numbers simply will not add up for banks." Read the full opinion piece online here.

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