Americans need access to small loans for their financial security

Millions of Americans rely on short-term, small-dollar loans to get by in a pinch, cover unplanned medical bills, cover recurring expenses just outside their means, and even put food on the table. In the most comprehensive analysis on the subject yet, Pew Research found that payday loan borrowers spend $7.4 billion annually at 20,000 storefronts, hundreds of websites, and an increasing but small number of banks. That’s big business and demonstrates a real, if unfortunate, need. Rather than make it harder for lenders to satisfy this need, as the recent rule from the Consumer Financial Bureau Protection did, regulators need to seek more constructive solutions that allow consumers to satisfy this need safely and fairly, until the underlying reason for such lending disappears.

Today, rather than protect consumers, laws and regulations regarding payday lending have evolved in ways that push people into increasingly darker corners of our financial system, making them more susceptible to abuse. At the same time, by creating a stigma regarding payday lending and making payday lenders and borrowers pariahs, regulations and laws at state and federal levels prop up prices by discouraging competition from more mainstream lenders. The results are often loan terms that are unfair to consumers, debt traps, and three-digit annual percentage rates. The annual rates soar as high as a whopping 591 percent in Ohio, the highest rate for payday lending in the country.

{mosads}The abuses common in the payday lending industry are real, and they continue to occur today. Where the abuses occur, they must be stopped, but public policy ought to encourage the provision of these products by banks and other prudentially regulated financial firms. Prudential regulators have shown that they are willing and able to curb abuses. For example, the Office of the Comptroller of the Currency pioneered a legal enforcement approach in the early 2000s to be the first federal banking agency to issue comprehensive anti-predatory lending guidance and regulations and to take enforcement actions against abusive practices related to payday lending occurring within the federal banking system. The OCC also recently repealed its guidance related to deposit advance products as another step to encourage banks and thrifts to explore ways to meet the short-term, small-dollar loan needs of their customers.

In the past, even though the agency continued to encourage banks and thrifts to find innovative means of meeting the short-term, small-dollar loan needs of customers, such lending virtually disappeared within the federal banking system. Banks were not going to take risks to offer a marginally profitable product that regulators clearly disfavored. Intentional or not, the effect was chilling. Recognizing this unintended effect was one reason supporting rescission of that guidance in October. We must learn from our past experience and take care to avoid “regulating consumers with limited credit options out of the banking system,” as Rep. Trey Hollingsworth (R-Ind.) has said.

There has to be a better way. One way would be to encourage more competition, not less. If a borrower could turn to a more regulated bank to satisfy their short-term credit need at a fraction of the average rate that exists in that state today, wouldn’t that be incrementally better? Perhaps rather than highlighting all of the risks and pitfalls of serving consumers that restrict access to credit, regulators could offer broad principles of safety, soundness and fairness that would allow lenders to innovate to deliver products that have a greater conscience.

Congress could go as far as requiring federal banking regulators to jointly issue a regulation in this area that deals with the problem from a solutions perspective rather than a protectionary one. In considering any rule or statute, policymakers must take care to remember short-term, small-dollar loans are commercial credit products, and banks need to be free to price the product according to their risks, just as they do for other loans they offer. The increased competition and the removal of any stigma associated with such products will drive the price of those products lower in a sustainable fashion.

If Congress and the public wanted to eliminate access to such a product, it could have outlawed them as several states have. But outlawing the product would not erase the need for access to such loans, and we should not prevent banks and financial service providers from lawfully and responsibly fulfilling that need.

Keith A. Noreika is the acting U.S. Comptroller of the Currency. He was previously a partner and member of the financial institutions practice at Simpson Thacher & Bartlett, where he focused on banking regulation.