Three major banks — Wells Fargo, Truist, and Regions Bank — announced plans in January to introduce small loan offerings to their checking account customers. If their loans give customers time to repay in affordable installments at fair rates, like existing small loans from US Bank, Bank of America and Huntington Bank, that’s good news for consumers and could be high compared to payday and others Loan costs lead to significant savings.
But not all small loans are safe just because they come from a bank: Expensive and risky third-party loan arrangements, better known as rent-a-bank, allow payday lenders to take advantage of a banking partner’s charter on expensive loans that state laws and regulations dictate circumvent consumer protection measures.
Several state-licensed banks operated by the Federal Deposit Insurance Corp. (FDIC) have begun making expensive loans to payday lenders in recent years. As the Office of the Comptroller of the Currency (OCC), the FDIC and other federal bank regulators consider new guidance on how banks can better manage third-party risk, they should take this opportunity to examine the expensive lending partnerships among a few of those regulated by the FDIC banks.
Research by Pew Charitable Trusts has identified the detrimental impact that unaffordable, short-term credit is having on the financial stability of many low-income consumers. Americans spend more than $30 billion borrowing small amounts of money from payday, auto title, pawn shops, hire-purchase and other high-priced lenders. Payday loan borrowers end up paying an average of $520 in fees over five months a year for an average loan of $375. Fortunately, state laws and federal policies have resulted in some lower-cost loans entering 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 of the banking system, many states allow payday loans with few safeguards — while others choose to effectively ban payday loans. And some states allow payday loans, but only with strong consumer protections. But even in states that protect consumers, unlicensed payday lenders are increasingly using Rent-a-Bank agreements 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 proliferation of these rent-a-bank agreements should alarm federal regulators at the OCC, the Consumer Financial Protection Bureau, and especially the FDIC — as these partnerships are driving higher costs and consumer harm, rather than expanding access to better credit.
Our research has found that consumers turn to expensive credit because they are in dire financial straits, often living paycheck to paycheck. Lenders know full well that such consumers are looking for quick and convenient credit, so they can charge excessive fees. Without strict rules for affordable payments and fair prices, consumers end up in long-term debt and feel taken advantage of.
Small loans can help meet the needs of consumers struggling with financial insecurity. But a safer and much cheaper solution than rent-a-bank arrangements would be for banks to follow the example of Bank of America, US Bank and Huntington Bank and offer small installment loans or lines of credit directly to their customers – with fair prices, affordable payments and a reasonable repayment period. These banks’ offerings cost borrowers at least five times less than offerings from FDIC-regulated Rent-a-Bank lenders. Pew has found that affordable loans like these could save millions of borrowers billions annually.
As vulnerable consumers continue to face fluctuations in income and spending, the FDIC, which will have new leadership, should act decisively to halt risky Rent-a-Bank loans — whose loss rates are far higher than any other product in the banking system . Normally, bank auditors would shut down such dangerous programs, but the poor results of these loans remain hidden from the auditors — because banks, which largely do not keep the loans on their books, are quick to sell most or all of them to payday lenders. But their high loss rates still show up in payday lenders’ earnings reports. Therefore, it is still possible for the FDIC to identify that these are high-risk, high-loss payday loans.
Cheap small installment loans from banks are helping consumers, and regulators should welcome them. But Rent-a-Bank loans aren’t affordable — and they have no place in the banking system.
Alex Horowitz is an officer and Gabe Kravitz is an officer at The Pew Charitable Trusts consumer finance project.