As the Biden administration leads its cabinet nominees through the Senate confirmation process, experts of all stripes are offering predictions on how banking regulation might proceed under a president who promises greater protections for vulnerable Americans.
One area that is frequently discussed is small dollar loans, which include, but are not limited to, payday loans.
Greater regulation for the small dollar space is necessary and has expired. But it is essential to understand first that space is not monolithic.
Instead, small dollar loans are a spectrum that stretches from major banks to peripheral players, including pawn shops and payday lenders. At best, small dollar loans are a vital bridge to more than 60 million consumers, who lack access to credit and who live without essential savings: the majority of the country. And at worst, there are well-documented cases of negative situations that are further exacerbated by cycles of unaffordable debt.
Given the disparity of actors that exist within the small dollar lending space, and because its borrowers are among the most vulnerable, it makes perfect sense for the Biden administration to focus on the space. However, the goal of any regulation should be to ensure that even those consumers who may have poor credit have access where appropriate, and to bring more consumers closer to conventional financial services.
The alternative – pushing struggling consumers to the less regulated periphery, making them more prone to predatory debt traps – is the wrong solution. Striking the right balance from a public policy perspective will require precision, but it is still quite doable.
A logical first order of business would be reinstate small loans from the Consumer Financial Protection Bureau rule that requires lenders first to ensure borrowers have the ability to repay before issuing loans. Lenders who don’t do this for low-value loans generally rely on fees and reinvestments for profit, often leading to more difficult consumers trying to pay off their debts.
It is also important that any potential regulations address the rampant problem of borrowers needing to obtain additional loans to pay off an initial loan. Too often, partial interest payments only lead to crushing debt cycles that fail to reduce your principal balance. Mortgages, on the other hand, amortize the principal with each payment. The same concept, in the sense that all payments must pay part of the principal, should apply to all small loans.
Additionally, prohibiting late fees, insufficient funds fees, origination fees, and prepayment penalties could help lower costs to prevent consumers from having to roll over their debts. Policy makers should also take a closer look at debt collection policies.
Some of the larger federally regulated banks that have direct visibility into key underwriting data, such as cash flow, have created low-value products that target greater inclusion of those left behind in mainstream financial services. . This should help these consumers gain better access to traditional products, including mortgages.
However, the number of banks that offer these products and the restrictions they have, do little to solve the problem of access to credit.
Where well-intentioned regulation could backfire and harm consumers is by taking too scattered an approach or applying ideas that have outlived their useful life. Limiting interest rates to an annual percentage rate of 36%, as some states have done, is a prominent example, although federal and state-licensed banks take precedence over interest rates.
Proponents with pride trumpet tradition rate cap dating back to the early 1920sth century with little recent study of its impact. But today there are virtually no public policy discussions that should be guided by metrics designed so long ago that only men could vote at the time.
In fact, just before the pandemic, California implemented a 36% APR cap on loans of $ 10,000 or less, driving traffic to sovereign lenders and payday loans, according to a 2021 report from TransUnion. This created the opposite effect that the legislation tried to implement.
However, more important than the age of an idea are its practical implications. recently shown that loans must be $ 2,530 or more for lenders to simply cover costs by charging a 36% rate. A loan of $ 594, for example, would require a three-digit rate.
It is difficult to call breaking even “predator”. It is also important to understand that if a business cannot justify offering a loan product from a dollar and cent perspective, the product will not exist.
When it comes to helping consumers gain access to traditional forms of credit, small dollar loans provide the lowest entry ramp for banks to offer broader access to the US financial system. It is important to recognize that if done well, there is an opportunity to serve the common good more broadly.
Small loans are necessary. They are viable and can improve financial outcomes for people that the traditional system might overlook.
While regulation must eliminate the ability of bad actors to operate within the space, new regulation must also be careful not to hamper emergency credit flows to millions in desperate need.