Large banks uncertain of path forward on small-dollar loans

Almost four years after banks ditched the deposit advance business, some are eyeing a return, looking to take a different tack this time around.

But it’s unclear what their business model would look like.

That was a key takeaway from third-quarter earnings season, which wraps up this week. At least two big banks — Fifth Third Bancorp and U.S. Bancorp — expressed interest in getting back into short-term credit, once a significant source of fees, while others are reviewing their options. But executives said it is too early to talk about how they plan to design a loan that is profitable for their companies and safe for consumers.

“We’re trying to figure out what the right answer is,” Greg Carmichael, CEO of Fifth Third Bancorp in Cincinnati, said in an interview after his company’s earnings call, noting recent changes in the regulation of small-dollar lending. “What’s most important is that … we can help our customers when they have emergency shortfalls.”

Asked how U.S. Bancorp in Minneapolis would generate revenue from a small-dollar loan product — either through interest income or through fees — Chief Financial Officer Terry Dolan said it was simply too early to say.

“Don’t even know that information,” Dolan said in a follow-up interview after U.S. Bancorp’s call, emphasizing that the company was in the early stages of planning. "You could certainly see ways that it could be structured as a deposit service charge."

The lingering sense of uncertainty is notable.

Banks generally had exited the business to avoid running afoul of payday- and anti-predatory-lending rules. Yet last year several big banks were on the verge of jumping back into the small-dollar lending business with a detailed plan to provide short-term installment loans that they said would solve the problem.

The business opportunity appears clear. According to a recent survey from the Pew Charitable Trusts, more than 80% of payday loan customers said they would prefer to borrow from a bank.

Yet the regulatory landscape is as choppy as ever.

The Consumer Financial Protection Bureau released its long-awaited payday rule in October, imposing stricter underwriting standards on loans of up to 45 days. Banks reentering small-dollar lending would have to carefully steer around that rule's requirements.

On the same day, the Office of the Comptroller of the Currency rescinded guidance that discouraged banks from offering deposit advance products, typically designed as short-term credits with one-time payments. Similar guidance from the Federal Deposit Insurance Corp. remains in place.

“[I]t has become clear to me that it has become difficult for banks to serve consumers’ need for short-term, small-dollar credit,” acting Comptroller Keith Noreika said in a press release announcing the change.

In the coming months, it is unlikely that the OCC will issue guidance laying out a detailed path forward on small-dollar lending. Instead, the agency will likely take a proactive approach to working with banks interested in designing a small-dollar loan, said Valerie Hletko, an attorney with Buckley Sandler.

“It’s a great opportunity to have a regulatory laboratory," Hletko said in describing the challenge of designing a profitable small-dollar loan within the current regulatory patchwork. “They’ll let banks be guided by their good judgment, typically in consultation with their examiners."

National banks such as U.S. Bancorp could potentially design a deposit-advance product that avoids the more onerous underwriting standards proposed under the CFPB’s payday rule, attorneys said.

Key elements of such a loan would involve a term of longer than 45 days and no balloon payment, experts said. A simple cost structure and consumer disclosures, of course, would also be important.

Still, consumer advocates said it is unlikely that banks would be interested in reviving anything that resembles their old deposit-advance products, which attracted significant controversy several years ago. A handful of big banks — U.S. Bancorp, Fifth Third, Wells Fargo, BOK Financial and Regions Financial — exited the business in January 2014, under pressure from regulators.

“I truly hope that the banks aren’t thinking about going back to the old deposit advance products,” said Lauren Saunders, an attorney with the National Consumer Law Center. “They were payday loans by another name.”

Asked whether they were eyeing a return to small-dollar lending, neither Wells nor BOK expressed interest. Both companies are regulated by the OCC.

“The OCC’s latest guidance doesn’t change things for us,” a spokeswoman for the San Francisco-based Wells said in an email.

BOK has “nothing substantive to add at this time,” said a spokeswoman for the Tulsa, Okla., company.

Regions, meanwhile, is “reviewing the updated regulatory guidance related to small-dollar lending,” a spokeswoman for the Birmingham, Ala., company said in an email.

Regions and Fifth Third are state-chartered banks, and the Federal Reserve is their primary regulator.

With the future business model for small-dollar lending somewhat in flux, consumer groups are urging the banking industry to consider a number of new approaches.

One such idea that has gained the backing of Pew and other groups would involve designing small installment loans with monthly payments capped at 5% of a borrower’s monthly income.

The loans could be for a few hundred dollars and due over several months, to fit within the budgets of low-income customers, according to Nick Bourke, director of consumer finance at Pew.

“I think there are a lot of banks that were not part of deposit advance, that are looking at making small installment loans,” Bourke said. He noted that automating the underwriting process would also make the loans profitable.

Even small installment loans, however, could still trap borrowers in unwanted cycles of debt, according to Rebecca Borne, an attorney with the Center for Responsible Lending.

To avoid this, banks should assess borrowers’ recurring monthly expenses — in addition to their monthly income — to ensure they have the means to handle the monthly debt service.

“The expense side of the equation is critical,” Borne said.

In the coming months, consumer groups said they will be looking for more detailed guidance from regulators, and listening for information on how banks plan to move forward.

“We’ll see whether one or two test the waters,” Saunders said.

During U.S. Bancorp’s earnings call, CEO Andy Cecere said the company was looking to offer a new product in the coming quarters. Fifth Third said it is too early to commit to a timetable.