Since being appointed as the U.S. Comptroller of the Currency in 2017, former banking executive Joseph Otting has advocated for big banks to offer small, short-term loans to individuals in need of emergency cash. The Office of the Comptroller of the Currency stated in May that nationally chartered banks should offer “responsible short-term, small-dollar installment loans” of two to 12 months structured to feature regularly payments rather than having the full amount due when the loan matures.
Banks have, in recent years, avoided making these types of loans due to regulations that tightened underwriting guidelines, as well as consumer backlash over past high-cost lending products. “Payday loans,” as they are commonly known, are typically sought by low-income borrowers with poor credit histories. Borrowers promise payments from future paychecks at interest rates that can soar as high as 400 percent on an annual basis.
Recently, a federal judge denied a request by acting Consumer Financial Protection Bureau Director Mick Mulvaney to delay tougher restrictions on small-dollar loan providers set to take effect in August 2019. Under the “small-dollar” rule, lenders would be required to determine a borrower’s ability to repay short-term loans of 45 days or less.
Harbert College of Business finance professors Jim Barth and John Jahera proposed in a 2016 editorial for AL.com that banks be allowed to compete with payday lenders. In 2015, Barth, Jahera and Harbert College doctoral candidate Yanfei Sun assembled a database of laws in the 36 states where payday loans are offered, as well as the number of payday lending stores per state. They also analyzed the impact of state laws on payday lender operations.
In this Q&A, Jahera, the Harbert College’s Lowder Professor of Finance, discusses the implications of nationally chartered banks entering the payday lending sector:
Why aren’t banks engaging in payday lending activities?
John Jahera: “There are a couple reasons why many banks do not engage in payday lending. First, the low dollar amount of such loans, typically $300 to $500 does not always generate enough profit for banks. Second, bank regulators until very recently have frowned upon such lending as predatory and, in fact, Operation Chokepoint was a program to discourage firms from entering certain businesses deemed unfavorable. Bank regulators wanted banks to do complete underwriting to assess a borrower’s ability to repay. Such a credit investigation is simply too costly for such a small loan. The CFPB had proposed such rules, however. But under the current administration, those rules have been rescinded.”
Do we need payday lending in the U.S.?
Jahera: “Payday lending shows high demand. In Alabama, once mandatory reporting was adopted, the number of such loans per week was around 42,000. So it is clear that demand for small dollar, short terms loans is there. The question is how best to meet that need.”
What about the high rates of interest on payday loans? Are they predatory?
Jahera: “Interest rates are indeed high when measured on an annual basis. But the rates reflect the high risk nature of such loans. One advantage a commercial bank would have is a much more diversified loan portfolio so losses could be spread around the various loans. Opponents of payday lending often refer to the industry as predatory -- that is, preying up on the less fortunate. Research has shown that such stores tend to locate in less economically prosperous areas. While the research is mixed, some have found that areas with large African-American populations have more payday lenders. Of course, the industry would argue they are simply going to where the demand is.”
Should banks be encouraged to enter that market?
Jahera: “Yes, in my view it would be good on many fronts. First, we still have a large number of bank branches around the country. Second, this would enable unbanked people to establish a banking relationship that could help them build a credit score and perhaps open the door for other banking services. Keep in mind that the rates though on such loans will still be high relative to secured loans given the higher risk nature. So we should not expect to see a dramatic drop in the rates on such loans.”