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.