Small-dollar loan formula eludes banks, credit unions

Bank and credit union regulators are looking at ways to responsibly promote small-dollar lending.

The National Credit Union Administration, which recently implemented a new payday alternative loans (PALS) rule, is mulling new ways to encourage credit unions to find ways to address their members' short-term cashflow issues.

The agency’s approach is mirrored at federal banking regulators that continue to discuss the possibility of a new rule, or fresh guidance, on the issue months after Federal Deposit Insurance Chairman Jelena McWilliams indicated talks were under way.

The challenge for regulators, and the lenders they oversee, is to develop a workable formula for small-dollar loans.

The NCUA last week voted to update a nine-year-old payday alternative rule, doubling the loan limit to $2,000 and extending the repayment window to 12 months. It also eliminated the $200 minimum borrowing requirement, along with a stipulation that a borrower had be a member of the lending credit union for at least a month.

The update kept in place a $20 limit on fees, along with provisions blocking borrowers from receiving more than three PALS loans in a six-month period or having more than one outstanding loan at a time.

Many banks, meanwhile, are working with their regulators to find ways to make more small-dollar loans.

Reading Co-operative Bank in Massachusetts is in talks with the Boston Fed and its state regulator about offering an emergency loan product to consumers, said Julieann Thurlow, the $580 million-asset bank's CEO.

Reading began offering the loans to its employees after a Fed study, released in May, revealed that 60% of Americans would struggle to pay an unexpected $400 expense. The bank raised its maximum loan amount to $1,000 after realizing that many emergency expenses cost more than $400, Thurlow said.

The same concern about customers' struggles handling unforeseen expenses spurred the $473 billion-asset U.S. Bancorp to create its Simple Loan product.

“We’ve all seen the studies that show that [40% of] Americans can’t afford an emergency situation,” said Lynn Heitman, the Minneapolis company's executive vice president of consumer products. "That’s really what prompted us to consider how we could help our customers.”

Under Simple Loan, customers pay $12 to $15 for each $100 they borrow, up to a maximum of $1,000. Loans come with a three-month repayment schedule and feature annual percentage rates of 70% to 88%. Customers aren’t allowed to take loans that result in monthly payments equal to more than 5% of their gross monthly income, and they have to wait 30 days between paying off one loan and applying for another.

“The customer use of the product is as we expected,” Heitman said, without providing specific statistics.

“What they’re using it for, their understanding of the product, their comfort level with the product, all that matches and mirrors what we experienced during our pilot," Heitman added. "It was a very robust pilot and there was a lot of research we did ahead of time. Everything has progressed exactly as we thought it would.”

Heitman said the automation behind Simple Loan has been critical to its success.

“This product is only available digitally,” Heitman said. “Te design itself is so simple that w have not found it a hurdle at all. With so many bank products, there’s complexity, and a conversation with someone in one of our branches is important. In this instance, the product design itself was so simple, making it 100% digital was not a hurdle for customers.”

U.S. Bancorp is considering expanding the program.

“That’s some of the conversation that we’re having now as we learn more about how consumers are using the product,” Heitman said. “Are there other elements we can build around it that could help them create some additional stability in their financial lives?”

To be sure, some industry observers wish credit unions and banks would do more to make small-dollar loans available. Many view them as alternatives to businesses such as cash-cashing services.

Alex Horowitz, a senior officer at the Pew Charitable Trust’s consumer finance project, said small-dollar loans will fail to gain traction with credit unions unless the NCUA allows them to make more money on the product.

Lending under the NCUA's original loan rule totaled just $160.3 million for the 12-month period that ended June 30.

McWatters, for his part, believes credit unions must make more adjustments, including more automation, to meet members' needs.

“Small-dollar borrowers can’t wait a few days," he said. Serving in-need borrowers "requires scale, automation and not treating small dollar loans as one-off transactions.”

McWatters even suggested more collaboration between banks and credit unions to provide borrowers with the safest, and most financially responsible, products possible.

“If we can learn something from the banking regulators or they can learn something from us, we should all do that,” McWatters said. "Our bottom-line goal is to ensure safety-and-soundness and ensure robust consumer protection."