In late January, 14 State Attorneys General sent a letter to the Federal Deposit Insurance Company (FDIC) in response to a request for information on small dollar lending. NILA feels compelled to comment on this letter, which contained content that seemed to come from an earlier age, when the benefits to individuals and families in terms of financial capability and mobility of access to safe and affordable non-bank credit were not well understood, and where appreciation for differently structured loan-types and their relative strengths and weaknesses played no part in the development of public policy.
The AG’s letter begins by using terms like “traditional banks” and “fringe lenders”. These terms, less common now than in earlier years, speak to an assumption that the quality of a loan instrument may be gauged by who its provider is, and misses the point that commercial banks, whose primary role is to make loans to corporations, have never been significant, let alone “traditional” lenders to lower-income consumers.
The letter then compounds this by referring to “high-cost installment lenders.” Presumably they mean providers of loans that carry high APRs, and are unaware that there is an inverse relationship between cost and rate, as measured by the over-used and often unhelpful APR. There is also an inverse relationship between APR and TIP rates (Total Interest paid as a percentage of Principal). Thus, when they refer to “high-cost lenders” they mean “low cost, low TIP, high APR lenders.” To be fair, this is a widely-misunderstood point, but it is irrefutable, and we’d be happy to explain it to any AG that would like more details.
Of course, that opens the issue of the extreme folly of state “one size fits all” APR caps, which can be found in almost every state these AGs represent, to the detriment of their citizens. By treating all loans as if they were payday loans (widely recognized as problematic, potentially trapping borrowers in “the cycle of debt”), and imposing rate caps at levels which make all small dollar lending unsustainable, their policies act as a ban on the smaller and lowest-cost loans, from which lower-income citizens could most usefully benefit. “One-size-fits-all” caps make big loans to the wealthy legal, and small, cheap loans to the less well-off illegal, and are therefore inherently discriminatory. They effectively eradicate opportunities for individuals and families to improve their financial capability and begin the process of financial mobility.
There is some content that we welcome, however, including their concern about evasion. It is always better for loans to come from state-regulated and audited storefronts in communities, than over the internet. But it is an old truth, that you can legislate away the supply of legal, state regulated low cost credit, but not the demand. Better, more liberal state APR laws would give lower income borrowers the option of using such safe, affordable, and supervised loans. This would also solve the problem of rent-a-bank charters, which the AGs are right to deplore.
We also welcome the suggestion that banks be required to test the ability to repay, a hallmark of the installment loan. Banks, when they have entered this space, have typically relied on their control over the consumer’s account, in the form of payday-style deposit advance products. We welcomed elsewhere [LINK] the decision by U.S. Bank to start making small installment loans at a sustainable rate.
That is what the FDIC should be encouraging: helping banks to learn to be more like traditional installment lenders. Much of the public policy world appreciates the opportunity represented by wide access to safe and affordable installment credit. It remains to be seen whether these 14 Attorney’s General are willing to play their part in driving financial capability and mobility among lower-income citizens whose well-being is a key AG responsibility.