Banks + small-dollar credit doesn't add up

The Office of the Comptroller of Currency recently released a bulletin encouraging national banks and federal savings associations to offer short-term, small-dollar installment loans — and many industry observers believe that this will mark a new era in small-dollar lending. I am, however, skeptical that banks and similar lenders will actually offer this vital form of credit to the millions of consumers who need it, because the truth is, banks largely find loans of a few hundred dollars unprofitable and unsustainable due to the high cost and risk of offering these products.

The Community Financial Services Association of America, which represents the small-dollar lending industry, has always welcomed competition in this market. We fully believe that competition is a win for consumer choice as it helps spur innovation, which in turn improves products and services while reducing costs.

Federal data suggests there’s ample need for this type of credit. According to the Federal Deposit Insurance Corp.’s 2015 survey of unbanked and underbanked households, which is the latest data available, 7% of U.S. households were unbanked in 2015, representing 15.6 million adults and 7.6 million children. The same survey also found that nearly 20% of U.S. households were underbanked, meaning that the household had a bank account but also obtained a financial service or product outside the banking system, such as a small-dollar loan. What’s more, the latest Federal Reserve report on the economic well-being of U.S. households found that 40% of Americans either could not cover or would struggle to cover an unexpected expense of $400.

However, history has shown that banks don’t do well in meeting the credit needs of the small-dollar-loan borrower. In 2009, for example, the FDIC tested a pilot program for small-dollar loans to explore the viability of banks offering small-dollar loans. The program specifically allowed banks to offer small-dollar loan-type products with a 36% interest rate cap — yet those products proved unprofitable in the short term. And in response to this recent OCC bulletin, American Banker reported that banks are “responding cautiously to the latest federal push to encourage small-dollar loans to consumers with blemished credit, a sign of lingering skepticism about the business opportunities in the subprime market.”

If banks truly could serve the small-dollar loan customers profitably, they would. Instead, they have in large part abandoned certain communities, leaving them underbanked or unbanked and writing them off as poor prospects. Such consumers tend to keep small account balances and are unlikely to gravitate toward more profitable bank products.

Competition is good, and we welcome new entrants into the industry. But the financial community must be even more innovative in providing banking services to those who now barely enjoy them, while working to best serve the millions of hard working Americans who struggle to bridge financial gaps or pay for unexpected expenses. For decades, banks have been unwilling to enter the short-term, small-dollar credit market, and I am skeptical that this new guidance or encouragement from the OCC will materially change this fact.