Lending is a service business. The word “service” is essential because it reflects the relationship between borrower and lender. The term “business” is just as crucial because lending is a business. If lenders cannot cover costs and generate a profit, there is no reason to lend. And for the investors who support the lenders, there would be no reason to invest.
Today’s read is from CNBC, and it covers the topic of lending caps on small-dollar loans. Small-dollar loans are often called “PayDay” loans because their intent is to bridge the borrower to their next payday, where they can clear their obligation.
Payday borrowers perform differently from bank-grade retail loans. Most customers with strong FICO Scores have a wide range of options, but for those without credit files or are credit-impaired, there are fewer options.
CNBC cites a well-known Payday lending study done by Pew Trust. In the 32 states where Payday lending is permitted, the interest rate approaches 600%. Another citation from the CFPB found that 25% of payday loans refinance nine times.
Payday lending is an endless loop, but will mainstream lenders fill the void? And if so, who will pay for the credit losses?
- Major banks are not totally unbiased on the subject of small-dollar loans. Although banks generally don’t provide small-dollar loans, that is changing.
- In 2018, the Office of the Comptroller of the Currency gave the green light to banks to start small-dollar lending programs. Meanwhile, many payday lenders contend that a 36% rate cap could put them out of business, potentially giving banks an advantage.
- If payday lenders ceased to operate because of a federal rate cap, it could force consumers to utilize banks offering these loans.
Payments Journal called the issue out in 2018. In Mercator’s field test, I tried a Payday loan to get a frontline experience. The customer experience was fine. The office was clean, the staff competent, and the money was green. For a $100 loan, I paid $10 for a two-week term. $10 might sound inconsequential, but the annualized rate put the cost at over 200% for the loan. And I have an excellent FICO Score.
The CNBC article highlights a recent U.S. Senate Committee hearing on banking. Called to the hearing were the top names in U.S. banking today: Mr. Charles W. Scharf, CEO and President of Wells Fargo & Co.; Mr. David M. Solomon, Chairman and CEO of Goldman Sachs; Ms. Jane Fraser, CEO of Citigroup; Mr. Jamie Dimon, Chairman and CEO of JPMorgan Chase & Co.; Mr. Brian Thomas Moynihan, Chairman and CEO of Bank of America; and Mr. James P. Gorman, Chairman, and CEO of Morgan Stanley.
One of the many topics covered in the hearing was payday lending. The august group was asked “if they would support a 36% cap on interest rates on consumer loans like a payday loan,” According to CNBC. Feedback cited by CNBC included:
- The bank CEOs did not immediately reject the idea. “We absolutely don’t charge interest rates that high for our customer basis,” Citi CEO Jane Fraser said in response to Sen. Reed’s question. She added that Citi would like to have a look at the law, to make sure there are no unintended consequences to it. “But we appreciate the spirit of it and the intent behind it,” she said.
- The CEOs of Chase, Goldman, and Wells Fargo agreed they’d like to look over any final legislation, but all expressed openness to the idea.
- David Solomon, CEO of Goldman Sachs, said that he wanted to ensure that a “materially different interest rate environment” didn’t close off lending to anyone. “But in principle, we think it’s good to have this transparency and to look carefully at this,” he said.
- Brian Moynihan, CEO of Bank of America, said that he also understood the “spirit” of the law.
There are a few issues. Although sky-high rates can be predatory or usurious, no one is forcing the borrower to borrow. And, if the transmission is on the fritz, or the baby needs food, where else do you get it? Instead of downgrading financial institution balance sheets, should there be a federal or state resource?
With the potential of capping loans at 36%, the payday lending industry will soon die. Now, if you extend that topic to credit cards to force rates down into the 20% range, many borrowers will be locked out of the borrowing world, and with that, the economy will feel pain with reduced purchasing and more risk-averse lenders.
Overview provided by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group