By William M. Isaac and Reverend DeForest Soaries
Markets work best when they have strong competition and consumer participation. Our current financial system stands to improve on both fronts.
According to the Federal Deposit Insurance Corporation (FDIC), 92 million Americans are unbanked or underbanked, often without access to credit and the financial know-how to pursue other lending options. At the same time, regulators are throwing up roadblocks for new business models that bring these disenfranchised consumers back into the fold by offering them legal and responsible small-dollar credit access at competitive rates. Shutting these innovative models out of the marketplace both decreases competition and consumer participation – everybody loses.
The reality is, most unexpected credit needs aren’t for tens of thousands of dollars. They’re for a few hundred dollars, to cover unexpected urgent costs like a car breaking down or an emergency root canal. When people who do bank at a traditional institution need a small-dollar loan for situations like these, they’re often surprised to find that banks don’t offer this service.
In 2008 only 31 banks in the entire country offered loans smaller than $2,500, according to the FDIC. Since then, major players like Wells Fargo, U.S. Bank, and Regions have discontinued their small-loan products due to regulatory pressures.
As a result, the situation is becoming ever more dire for the unbanked and under-banked, a group which includes 54 percent of African Americans. Research has shown that more than half of the population can’t access two thousand dollars in case of an emergency. Because of their poor or non-existent credit history, the only place for many disenfranchised consumers to turn has historically been predatory lenders or illegal loan sharks.
All consumers – especially the unbanked and under-banked – need access to regulated, responsible small-dollar loan options, so that in their effort to build credit or climb out of debt, they don’t fall further down the ladder. Opponents to this access are overwhelmingly driven by objections to interest rates. In their view of the world, if the rates are “high” (by whatever standard they choose to set), then the loan must be bad. If the rates are low, then a loan is acceptable. This kind of flawed one-dimensional analysis fails to capture all of the factors that influence consumer choices and benefits, and it is well past time for serious people to move beyond simplistic and false rhetoric and engage on the issue in a truly substantive way.
The growth of online installment loans presents an innovative and sensible solution. Installment loans are characterized by the equal payments that individuals pay back over an extended period, in contrast to balloon payment loans that require the entire loan amount plus interest to be repaid in only two weeks or so. This, along with the detailed repayment schedule consumers receive, helps them budget appropriately and reduces the likelihood that they will have to take out an additional loan to repay their first one (known as “rolling over” the loan).
Consumers who still have trouble making payments have multiple options provided by installment lenders, typically including customer service call centers, complaint resolution procedures, and more.
Because of their consumer-driven culture – and because it’s the right thing to do – many online lenders are also providing consumers with financial education services, giving them the knowledge and support needed to make wise financial decisions. Getting onto sound financial footing is about more than just money – it’s about learning good habits and forming strong relationships. By empowering consumers with a strong foundation of financial knowledge, these lenders are helping to ensure consumers are financially prepared for emergencies and prevent the cycle of debt.
The innovative online model is on the front lines of the trend in businesses adapting to meet consumers where they are, using cutting edge financial services technology. E-commerce is the way people do business now, and consumers are showing this is how they want to bank. Fifty-one percent of U.S. adults bank online, and 32 percent bank using their mobile phones, numbers that will only continue to grow.
Regulators should be looking to online loans and banking as the way of the future, not viewing the industry as a scary “unknown.” Responsible regulations can and should continue to evolve – but in a way that encourages innovation, not ties it up in red tape. Increased competition will ultimately benefit consumers through lower prices and better products.
Unfortunately, regulators in many cases aren’t taking this path, and instead are pursuing new rules to further curtail short-term loans to consumers. If this continues, the under-banked consumers who count on these businesses for access to credit would be left with nowhere to turn.
Congress and others are taking notice. The House Committee on Financial Services Subcommittee on Financial Institutions and Consumer Credit will hold a hearing on February 11 to discuss the Consumer Financial Protection Bureau’s (CFPB) “Assault on Access to Credit.” The next day, we’ll be jointly speaking about all of these issues at “Wiring the Rez: Expanding the Borders of Indian Country through E-Commerce,” hosted by the Sandra Day O’Conner College of Law at Arizona State University.
As a former regulator and a consultant to financial institutions, and as a consumer advocate, we often view financial products through different lenses – and while we don’t agree on everything about small-dollar loans, we do agree that online installment lenders are offering an essential service to millions of Americans who have been excluded from the traditional banking system. They are filling a void, increasing consumer participation, and growing competition among providers – ultimately contributing to a strengthened market and better service for all. Regulators, including the CFPB, should work with these businesses to ensure they are responsibly regulated and consumer-friendly. To shut down innovation and leave the consumers who depend on them out in the cold is the wrong thing to do.
Isaac is the former chairman of the FDIC, and of Fifth Third Bancorp, and the founder of the regulatory consulting firm The Secura Group, now part of FTI Consulting where. Isaac serves as senior managing director. Soaries is senior pastor of First Baptist Church of Lincoln Gardens in Somerset, New Jersey, the former secretary of State of New Jersey and a consumer advocate who founded dfree®, a transformational, lifestyle movement that promotes financial freedom through values-based principles and practical approaches to financial management.
Advances in online communications have revolutionized many industries in recent years. While Uber and its impact on taxis may have garnered the most attention, similar forces have been reshaping vast swaths of the American economy. Yes, established firms have seen their positions eroded, but consumers have received tremendous benefits and, in many instances, so have the employees of these new enterprises.
All too often, however, government has sided with established incumbents, instead of consumers. Policymakers continually fail to embrace technological and entrepreneurial innovations that are a net benefit to the economy and thereby stifle efficiency and competition.
I can still recall, way back in the heady days of the first term of the Clinton presidency, when a Borders opened near my home. I've long loved strolling around bookstores (and record stores). Still do. Borders seemed to offer everything my small local bookstore was missing. But then just over 20 years ago a new player arrived on the scene, Amazon.com.
Just as Borders disrupted the small bookstores, it was later displaced by Amazon. Over the last decade alone, about a third of bookstores in the U.S. have closed. But I read more than ever and likely spend as much time browsing Amazon as I did wandering around Borders. Not to mention tracking down books I would have never been able to find. As importantly, at least for the consumer, margins have been compressed. More choice, lower prices — what's not to like?
Books and cars have not been the exception. Online travel services have greatly reduced the demand for travel agents. TurboTax has likely eliminated many a job in accounting. Hotels are being directly attacked by Airbnb and others. Wikipedia drove the last of the encyclopedia salesman out of work. Email has increasingly marginalized the Postal Service. Even college professors are under pressure from online education options.
In my own area of study, finance, greater competition has come on a number of fronts. eTrade, and others, have increased competitive pressures on stockbrokers. Apple Pay, BitCoin, PayPal and many others are shaking up the payments space. When investor advisors are not being attacked by Washington, they have to worry about online advisors like Betterment. Online installment and payday lenders are taking on banks, along with their brickandmortar competitors.
We are likely witnessing the greatest technological shakeup in finance since the creation of the ATM. Even ATMs are being competed against by the ability to make deposits via your phone.
Looking outside the U.S., the impact has occasionally been even more extraordinary. MPesa, a completely mobilebased money transfer, has changed the face of banking and commerce in Africa, while also making inroads into Eastern Europe and the Middle East. MPesa has undoubtedly brought millions on the formal financial system, while also reducing crime and increasing commerce. Perhaps the most stunning fact about MPesa is that it didn't originate in the financial system, but was created by a telecom company.
Such would have been impossible under Americanstyle banking regulation, which erects high walls between banking and other financial sectors of our economy.
The plight of the unbanked and the lack of competition in finance are not isolated to Africa, as it characterizes the U.S. as well. Unfortunately the response to the financial crisis has been to raise even higher barriers to entry into banking, rather than address the guarantees and resulting moral hazard that drove the crisis. DoddFrank's Financial Stability Oversight Council (FSOC) has already encouraged a number of large nonbanks, like MetLife, to shed the banking activities they had, further reducing competition.
FSOC isn't the only barrier to competing with banks. DoddFrank's Consumer Financial Protection Bureau (CFPB) aims to impose banklike supervision on nonbanks. This ultimately benefits banks, as companies that lack access to federal guarantees have more difficultly meeting bank regulatory standards without the funding advantages that banks have.
This is occurring with shortterm unsecured lending, such as that from installment and payday lenders. Online installment lenders, for instance, increase competition and consumer choice across state borders. The CFPB, and a number of states, are looking to impose further restrictions on these lenders that will only benefit their bank competitors, while also reducing consumer choice.
Just as governments tried to eliminate Uber, Airbnb and others, we are witnessing similar behavior among our financial regulators. There's even public evidence that some banks have encouraged the Federal Reserve to clamp down on BitCoin.
Whether intentional or not, our current system of financial regulation runs the risk of stifling innovation and competition from the digital domain. As mixing government guarantees with vigorous competition almost always results in bailouts, this is somewhat sadly understandable. But it is not inevitable. These potential entrants, such as BitCoin, online lenders, and many more, lack the government guarantees that drive moral hazard. Streamlining our financial regulatory system can ultimately serve to protect both consumers and financial stability.
Mark Calabria is director of financial regulation studies at the Cato Institute. Thinking of submitting an oped to the Washington Examiner? Be sure to read our guidelines on submissions.
Bill Isaac quite an expert in the field of finance and banking, and has some choice thoughts on the pros and cons of payday lending – small loans that typically do not attract any interest from banks and are typically sought by sub-prime lenders who turn to shady lenders for short-term loans of $200 – $300, to be repaid with fees and rates that are close to 400% in annual terms. So they’re really high cost loans made to people who can least afford the high interest. Bill talks about a new set of rules on payday lendingfrom the Consumer Financial Protection Bureau – and says this could really hurt those that really depend on payday lending and drive them into the arms of loan sharks and other unsavory characters.
In 1978, at age 34, Bill Isaac was tapped by President Jimmy Carter to serve as the youngest-ever member of the board of the FDIC. The position proved to be full throttle from day one – in fact, on his first day in office at the FDIC, Isaac was called down to Puerto Rico, where one of the territory’s largest banks, Banco Credito, was set to fail. Isaac was named Chairman of the FDIC in 1981 following the election of President Ronald Reagan. He served in that position through 1985 and is credited with preparing the FDIC for an onslaught of bank failures throughout the 1980s and into the 1990s.
Isaac is involved extensively in thought leadership relating to the financial services industry and policy makers worldwide. His articles are published in the Wall Street Journal, Washington Post, New York Times, Forbes and other leading publications. He also appears regularly on leading television and radio programs in the US and abroad, is a contributor to CNBC, testifies before Congress, and is a frequent speaker throughout the world on finance and regulatory matters.
While there is no racial bias in payday lending, they do target low-income people in dire need of money. But Bill makes the case that these loans actually provide quite a service to people who desperately need these loans, and are often their best alternative – provided, of course, you stop rolling it over, don’t pay your interest and dig yourself deep into a hole. But responsible payday lenders are cognizant of this and, in their own interest, prevent extensive rollovers of short-term payday lending.
When you consider where American technology innovation is happening in the United States, places like Silicon Valley or big cities on the east and west coasts might come to mind. As a fintech entrepreneur providing services to online lenders, my experience has found a thriving business community in places you might not think to look: American Indian Reservations.
Many American Indian tribes have been enormously successful launching sustainable businesses in high-growth industries. These tribes owe their success to the creation of well-fueled economic development processes. Indeed, some tribes are so singularly focused on business creation that once an enterprise is running, they bring on business partners to help with operations so the tribe can remain focused on the creation of their next new business.