the Department of Justice and state regulators are targeting banks that serve a wide range of what they see as dodgy financial businesses, including some online payday lenders. I applaud the government’s efforts to weed out bad actors who engage in fraudulent transactions or violate federal laws. But I’m deeply concerned about the unintended consequences this could have on much-needed financial services for underbanked people who depend on legitimate short-term lenders, commonly known as payday lenders.
The payday loan is quite simple. A person is in urgent need of short term cash and turns to a payday lender. A person with a job, checking account, and proper identification can borrow $ 100 to $ 500 until their next payday. These borrowers write post-dated checks or provide written authorizations to the payday lender for the loan amount plus a fee, which is typically 15%. On the next payday, the loan is either repaid in person by the borrower or the lender cashes the check or initiates an electronic funds transfer. That’s it.
Millions of middle-income Americans live paycheck to paycheck. They do their best to manage their finances so that all of their obligations are met. But when something unexpected happens, like a blown transmission, an unexpected doctor’s bill, or an urgently needed roof repair, their financial schedules are messed up and the need for short-term credit can arise.
Some turn to relatives or friends for help in a crisis. But many may be faced with the Hobsons’ choice of deciding between having their power cut, their car repossessed, their job lost, their unpaid rent or mortgage, or their bad check. Payday lenders offer a better solution.
Critics of payday loans cite the high interest rates they charge. A charge of $ 15 on a $ 100 advance for two weeks equals an annual percentage rate of 391%, or APR. This is high when expressed as an annual rate, but keep in mind that the typical term for these loans is a few weeks. It’s also worth noting that the annualized interest rate on average payday loans is much lower than the charge on a bad check or late mortgage or credit card payment.
The $ 15 cost of a $ 100 payday loan is also paltry compared to the income lost when a car goes out of service and a job is lost. Good payday lenders clearly disclose the terms of their loan, including the dollar amount of the fee and the APR. In addition, payday lenders are regulated and supervised by state agencies as well as by the new Federal Bureau of Financial Consumer Protection. My firm has worked with payday lenders to bring them into compliance with applicable banking regulations.
Some online lenders avoid regulation by establishing operations offshore or on an Indian reserve beyond the reach of regulators. I applaud the regulators for trying to put an end to such operations by denying them access to the banking system.
But I also warn of the potentially unintended consequences of keeping banks away from all payday lenders. It’s the last thing we need at a time when the economy is languishing, in large part because only the most creditworthy can qualify for a bank loan.
At this point, banks would be well advised to do due diligence with their payday lender customers to determine if they are in compliance with state and federal laws, have written regulatory compliance and anti-regulatory programs in place. money laundering, follow the best practices of professional associations and obtain valid client authorizations for direct funds transfers. If a payday lender can’t answer these questions in the affirmative, the bank is probably working with the wrong customer.
Some people claim that payday loan portfolios have huge losses because the loans never really get paid ?? just rolled over and over again. But most states limit the number of rollovers, and most payday lenders have similar limits, even in the absence of state laws.
The risks of payday loans are mitigated through the enormous diversification of portfolios, and the risks are built into the fees. It is possible for a reputable and efficient payday lender to maintain high loan loss reserves and substantial capital compared to payday loans while achieving decent returns.
Regulators would do well to examine the welfare of borrowers in various regulatory frameworks before acting in a way that could endanger the very people they are trying to protect ?? the under-banked. The truth is that millions of clients have a very favorable experience with the short term loan product, and we must be careful not to disrupt this important lifeline.
William Isaac, former chairman of the Federal Deposit Insurance Corp., is the global director of financial institutions for FTI Consulting, which has worked for payday lenders, and the chairman of Fifth Third Bancorp. The opinions expressed are his own.