BY LIN GRENSING-POPHAL
Conduct a Google search for “payday loans” and you’ll turn up 13.6 million results. The loans, offered through storefronts in virtually every city around the country, are so named because they originated as a means for people to “get enough cash to tide me over until payday.”
The downturn in the economy that started back in 2008, leading to high unemployment rates and a dearth of jobs, caused the demand for such quick loans to skyrocket to help people make ends meet. Predatory lenders were quick to emerge to offer help—but at a high price.
How Payday Loans Have Traditionally Worked The FTC’s web page on payday loans explains how they work:
“A borrower writes a personal check payable to the lender for the amount the person wants to borrow, plus the fee they must pay for borrowing. The company gives the borrower the amount of the check less the fee, and agrees to hold the check until the loan is due, usually the borrower’s next payday. Or, with the borrower’s permission, the company deposits the amount borrowed — less the fee — into the borrower’s checking account electronically. The loan amount is due to be debited the next payday. The fees on these loans can be a percentage of the face value of the check — or they can be based on increments of money borrowed: say, a fee for every $50 or $100 borrowed. The borrower is charged new fees each time the same loan is extended or ‘rolled over’.”
The page also makes it fairly clear that the FTC doesn’t look very favorably on these types of loans, noting that they represent “very expensive credit.” And they offer a number of alternatives to these loans to help consumers who need cash to tide them over other options they may not have considered. They’re even less favorably disposed toward online payday loans and have sued several online lenders for violating federal laws.
Recent approval from the Offi ce of the Comptroller of the Currency (OCC) may now offer a better alternative for those needing quick cash: national banks and federal savings associations. The OCC indicates that “U.S. consumers borrow nearly $90 billion every year in short-term, small-dollar loans typically ranging from $300 to $5,000.” Clearly, says David Wallace, global fi nancial services marketing manager at SAS, in the Raleigh-Durham area, “there is a market for lending that the banks are not in today.”
The OCC Bulletin
In May, the OCC issued a bulletin to encourage the banks it supervises “to offer short-term, smalldollar installment loans, typically two to 12 months in duration with equal amortizing payments,” says Catherine M. Brennan, a partner with Hudson Cook LLP, a consumer financial services law firm based in Maryland, with several offices around the country.
The move is designed to benefit those in need who currently fall prey to questionable tactics used by brick and mortar and online payday lenders. The OCC is encouraging banks to develop and implement programs that are consistent with existing, and sound, risk management practices and that they should align the programs with their overall business plans and strategies, says Brennan. “The OCC suggests that strategies could include working with consumers who have an ability to repay a loan despite a credit profile that is outside of a bank’s typical underwriting standards for credit scores and repayment ratios. In all programs, the OCC cautions that its member banks should offer lending products in a manner that ensures fair access to financial services and fair treatment of consumers and complies with applicable laws and regulations.”
Despite the go-ahead from the OCC, though, Quyen Truong, an attorney with Stroock & Stroock & Lavan LLP in Washington, D.C., says: “Banks are unlikely to offer loans that replicate those of payday lenders, given differences in their business models.”
Such quick, low-dollar loans represent high risk and don’t offer much profit, says Truong who also says that, “banks generally are also unwilling to accept the reputational hit from offering payday loans.” Still, Truong suggests, “many banks will want to meet these borrowers’ credit needs, as high demand continues, and the regulatory threat posed by the Obama administration recedes.” They may, therefore, offer products more similar to pre-Obama era offerings, says Truong—“such as deposit advance products (DAPs) as well as installment loans.” Such offerings could build on banks’ relationships with their customers,” Truong says.
How Banks Could Help Improve Payday Practices
According to Auburn University finance professor John Jahera banks are in a good position to enter the payday lending market, offering benefits to community members who are “unbanked people” and also positioning themselves for growth as these individuals build their credit scores. Banks haven’t engaged in payday lending, says Jahera, because of the law dollar value of such loans ($300-$500) and because bank regulators have, traditionally, frowned on the practice, considering it to be “predatory.”
There’s high demand, says Jahera, pointing to information now available in Alabama indicating that about 42,000 payday loans are made each week. He points to a number of benefits:
• The large number of bank branches around the country
• The ability for unbanked people to establish banking relationships
• Opening the door for other banking services in the future
While payday loan rates may be somewhat lower if offered through banks, as they could spread associated costs across their diversified loan portfolios, rates would still be higher than secured loans because of the higher risk involved.
Making it Work
Wallace says that “banks could do credit underwriting –also called credit decisioning—for consumers who don’t have traditional credit scores and repayment records,” what some call “thin file” he says. This could be done through artificial intelligence (AI) and machine learning (ML), Wallace says.
Banks are already well positioned to address the OCC’s concerns about “fair treatment” It’s something they already do, he says, “and they incorporate regulations into their underwriting process already. Banks also have the model risk management processes need to prove to regulators that credit decisions are fair and legal.”
But, do banks have the capacity to take on a large number of very small loans and would the work be worth it?
Wallace suggests that modern technology can plan an important role here, allowing banks to add external consumer data to traditional data for credit models.
This might include such pieces of information as data from utility providers, apartment rentals, mobile phone providers and other sources that would provide evidence of bill payment practices. In addition, he says, “other external unstructured data, including social media data that might show evidence of regular work in the gig economy where 1040s don’t get issues, could also be added to the models to assess repayment and default probabilities.”
AI/ML modeling techniques, including neural language processing (NLP) for unstructured data, and neural networks would be able to “analyze the ensemble of non-traditional data and help banks identify consumers who meet the bank’s risk management principles and underwriting standards,” says Wallace. “Banks can add external data about the consumer to traditional data for credit models. This data could include data from utility providers, apartment rentals, mobile phone providers and similar sources that show evidence of bill payment practices. Other external unstructured data including social media data that might show evidence of regular work in the gig economy where 1040s don’t get issued could also be added to the models to assess repayment and default probabilities. AI/ML modeling techniques including neural language processing (NLP) (for the unstructured data), and neural networks can analyze the ensemble of non-traditional data and help banks identify consumers who meet the bank’s risk management principles and underwriting standards.”
People don’t tend to like traditional payday loan providers. Many do like their community banks. The OCC ruling offers new opportunities for banks to reach out to underserved, and unbanked, members of their community helping them meet their financial needs today and providing a potential boost for their collective futures.