The Customer Effect
Banks’ foray into small-dollar loans adds pressure on payday-lending industry
- Banks' entry into small-dollar loan space could bring interest rates down and squeeze payday lenders
- Fintech startups see the OCC's move as an opportunity to work with banks on underwriting models
Payday lenders are about to face a barrage of competition from the big banks.
The OCC earlier this week gave banks the green light to enter the short-term loan market, reversing 5-year-old guidance telling them to stay away from it. The move adds pressure on an industry that’s facing threats from a CFPB rule that would require them to assess borrowers’ ability to pay and criticism that its business model is predatory and puts consumers into debt traps.
Payday lenders, however, say banks’ entry into the market isn’t necessarily a negative.
“Banks are already in the space -- they’re servicing customers with overdraft products that are more expensive than short-term loans, and this is a new way for them to serve that market,” said Jamie Fulmer, svp of public affairs at Advance America. “Competition is good for the marketplace.”
Fulmer said if banks get into small-dollar loans, regulations should be applied consistently to ensure a level playing field. While Congress’ deadline to overturn the payday-lending rule passed earlier this month, two industry organizations -- the Community Financial Services Association of America and the Consumer Service Alliance of Texas -- filed a lawsuit against the Consumer Financial Protection Bureau last month arguing it violated regulatory requirements.
If banks offer competing products -- small-dollar loans between $300 to $5,000 that customers can repay over a two- to 12-month period -- it could drive interest rates down overall, said Tom Miller, professor of finance at Mississippi State University.
“Competition affects prices -- banks and payday lenders have different models and costs of funds,” he said. But payday lenders still have an advantage in being open longer hours and during weekends and holidays, he added.
To ensure small-dollar loans are profitable, however, banks may need to charge interest rates comparable to payday lenders.
“Banks have said they need higher rates to lend to this market” to offset the risks of lending to customers who don’t have sufficient credit history or have low credit scores, said Corey Stone, entrepreneur in residence at the Center for Financial Services Innovation and a former assistant director at the CFPB. Without any direction on the rates banks could charge for the small-dollar loans, it’s too early to tell if will amount to a better deal for the consumer, he added.
Regardless of the direction regulators take, Fulmer said the industry has been evolving its business models to keep pace with a changing market, including looking at a broader set of data points to assess individuals’ ability to pay, and offering loans that could be paid over a longer period of time. It’s also looking at new investments in technology to better underwrite borrowers -- a move that was motivated by the shift from brick and mortar to online as the delivery channel for small-dollar loans.
To fintech companies, the OCC direction is a positive one; many are developing payday-advance products of their own. Chime, for instance, offers a free two-day payday advance for its customers. To data analytics company Quovo, the key problem to be solved is finding a better way to assess borrowers’ ability to pay -- an area where startups and banks can work together to better serve customers.
“An important part of improving our lending ecosystem is stripping the stigma from lending products that are used by lower-income borrowers,” said Quovo CEO Lowell Putnam. “Creating a holistic view of the borrower depends on alternative data sets, and fintech companies have already taken the lead leveraging alternative data for credit decisions.”