Under the letter of the law, banks can now reenter the small-dollar lending space. On Wednesday, the Office of the Comptroller of the Currency (OCC) issued new guidance encouraging banks to offer small-dollar installment loans. This follows the OCC rescinding prior guidance governing “deposit advance” products last year, which effectively enabled banks to offer a payday loan-type products again.
On its face, this is a great win for consumers. A Federal Reserve report issued this month found that around 40 percent of adults would not be able to pay an unexpected $400 expense without borrowing funds or selling a personal item. Opening up the small-dollar loan market to greater competition is a necessary and encouraging step to help fill an enormous need for small-dollar credit. However, it is naïve to think that banks are the complete answer to credit hungry consumers—or a replacement for non-bank installment and payday lenders, as some suggest. The truth is that such a diverse market requires a mix of lenders and products, including both bank and non-bank lenders.
First, it is less than certain whether banks will want to reenter the space. Back in 2013, the Obama administration regulated them out of the market through a handful of enforcement actions and guidance documents. While the current OCC may view market competition more favorably, a new administration in 2020 could all too easily institute new guidance prohibiting banks from the market. That kind of regulatory uncertainty is not helpful to firms.
Second, banks have an important but limited capability at serving such markets. Banks can certainly be competitive on loan price, with the average fee for a deposit advance product, for example, being around 10 percent, which is 5 percent lower than the average price of a payday loan. But price, it turns out, is but one out of a number of considerations in taking out a loan. While small dollar loans are relatively expensive (reflecting the risk and cost of administering such loans), non-bank installment and payday lenders are also quicker, easier, more confidential, tend to have better service, are open for longer hours than their competition, and tend to have more sustainable business models. Installment lenders in particular are more flexible in structuring their loans. This is often what customers’ value when taking out such credit. Perhaps that is why a Federal Deposit Insurance Corporation program that encouraged banks to make small dollar loans had rather meager results. So long as installment and payday lenders offer services that consumer value in a sustainable way—which they have for decades—they will likely remain as the most important players in these markets.
Whether it be deposit advance products, installment and payday loans, or new financial products enabled by modern technology, less government involvement is a good thing. Lenders should be free to compete for consumers by providing the best financial products that suit their customers’ needs. In such a complex economy, this will involve all kinds of lenders and products to satisfy the diverse needs of consumers. Yet inconsistent regulations at the state level, baring fintech and installment lending, and punitive regulations at the federal level, baring payday lending, create an uneven playing field, inhibiting competition and consumer choice. For example, while the OCC’s guidance reopened the door for banks to compete in the small-dollar loan space, it also cast doubt on whether fintech lenders can do the same. The OCC stated that:
The OCC views unfavorably an entity that partners with a bank with the sole goal of evading a lower interest rate established under the law of the entity’s licensing state(s).
Such a statement seems to call into question the business model for fintech firms that partner with banks to operate on a national scale (which is at odds with what the OCC has said previously.)
While the OCC’s move to encourage bank competition is to be applauded, we should not forget that installment, payday, fintech, and other lenders are all important components in the mix of consumer credit. Yet both federal and state governments have long discouraged these forms of credit over others. Instead of playing favorites, the government should open up all consumer credit markets to competition so that consumers, and not bureaucrats, decide which type of credit meets their needs.