Three large banks — Wells Fargo, Truist and Regions Bank — announced plans in January to launch small-dollar loan offerings to their checking account customers. If their loans give customers time to repay in affordable installments at fair prices, like the existing small loans from U.S. Bank, Bank of America, and Huntington Bank, that’s good news for consumers and could produce major savings compared with payday and other high-cost loans.
But not all small-dollar loans are safe just because they come from a bank: High-cost and risky third-party lending arrangements, better known as rent-a-bank, enable payday lenders to take advantage of a bank partner’s charter to make high-cost loans that bypass state laws and consumer safeguards.
Several state-chartered banks supervised by the Federal Deposit Insurance Corp. (FDIC) have begun originating high-cost loans for payday lenders in recent years. As the Office of the Comptroller of the Currency (OCC), FDIC, and other federal banking regulators consider new guidance for how banks can better manage third-party risk, they should take this opportunity to scrutinize the high-cost lending partnerships among a few of the banks regulated by the FDIC.
The Pew Charitable Trusts’ research has identified the damaging effects that unaffordable, short-term loans have on the financial stability of many low-income consumers. Americans spend more than $30 billion to borrow small amounts of money from payday, auto title, pawnshop, rent-to-own and other high-cost lenders. Payday loan borrowers end up paying an average of $520 in fees over five months in a year for an average loan of $375. Thankfully, state laws and federal guidance have led some lower-cost loans to reach the market, proving that effective rules and lower-cost options can save borrowers billions of dollars each year while maintaining widespread access to credit.
Outside the banking system, many states allow payday lending with few safeguards — while others choose to effectively prohibit payday lending. And some states allow payday lending but only with strong consumer protections. However, even in states that protect consumers, unlicensed payday lenders are increasingly using rent-a-bank arrangements to make loans that would otherwise be prohibited.
For example, in eight states, rent-a-bank lenders charge as much or more than state-licensed payday lenders. The spread of these rent-a-bank arrangements should alarm federal regulators at the OCC, the Consumer Financial Protection Bureau, and especially the FDIC — because these partnerships are leading to higher costs and consumer harm instead of expanding access to better credit.
Our research has found that consumers resort to high-cost loans because they’re in financial distress and often living paycheck to paycheck. Lenders know well that such consumers are looking for fast and convenient loans, so they can charge excessive fees. Without strong rules for affordable payments and fair prices, consumers end up in long-term debt and report feeling taken advantage of.
Small loans can help meet the needs of consumers grappling with financial insecurity. But a safer and much less expensive solution than rent-a-bank arrangements would be for banks to follow the lead of Bank of America, U.S. Bank, and Huntington Bank by offering directly to their customers small installment loans or lines of credit — with fair prices, affordable payments and a reasonable time to repay. Those banks’ offerings cost borrowers at least five times less than those offered by FDIC-supervised rent-a-bank lenders. Pew has found that with affordable loans like these, millions of borrowers could save billions annually.
As vulnerable consumers continue to confront income and expense volatility, the FDIC, which will have new leadership, should act decisively to stop risky rent-a-bank loans — which have loss rates far higher than any other product in the banking system. Normally, bank examiners would shut down such dangerous programs, but these loans’ poor outcomes are hidden from examiners — because banks, which largely don’t keep the loans on their books, quickly sell most or all to payday lenders. But their high loss rates nevertheless show up in the payday lenders’ earnings reports. So, it’s still possible for the FDIC to recognize that these are high-risk, high-loss payday loans.
Affordable small installment loans from banks help consumers, and regulators should welcome them. But rent-a-bank loans are not affordable — and have no place in the banking system.
Alex Horowitz is a principal officer and Gabe Kravitz is an officer with The Pew Charitable Trusts’ consumer finance project.