CRA: Payday Lending Under The CRA Microscope

The penultimate session at PCi's CRA and Fair Lending Colloquium was a discussion and debate on payday lending. The panel included Billy Webster, CEO of Advance America, a leading payday lender, and Arthi Varma, a consumer advocate with the California Reinvestment Coalition.

References to payday lending were interspersed throughout the conference, usually with unfavorable connotations. For example, John Taylor, President, National Community Reinvestment Coalition, stated that "payday lending couldn't be more antithetical to CRA." He essentially equated payday lending with predatory lending.

How Payday Lending Works
Payday loans are short-term loans - very short term. Typically, a payday loan is made for a term of two weeks. Payday loan customers must have a bank account which is used by payday lenders as a significant proxy for measuring financial responsibility. Underwriting includes several brief checks on the applicant's situation. These reviews do not include pulling a traditional credit report but do include checking with special reporting services that identify risks that are special to payday lending.Payday loans are usually made in amounts such as $100 or $200. The average amount is $250. Payday lenders charge a fixed fee for the loan. Fees are about $15 to $17.50 per $100.00 borrowed. This results in an affordable fee but an enormous APR. APRs are usually well over 400%.

Payday loans are unsecured loans made with minimal documentation. The term is short, and the risk and cost high.

Varma expressed concern that borrowers may become hopelessly indebted to multiple payday lenders, leaving the borrower worse off than before borrowing.

Webster explained that responsible payday lenders limit the number of times a loan may be renewed. For each renewal, the borrower pays a new fee. The more responsible lenders limit renewals or roll-overs to a maximum or 4 or 6.

Webster, instrumental in developing the industry's best practices, believes that payday lenders should not make loans to borrowers who lack the ability to repay. His company has a very low default rate.

Payday Borrowers
The customers of payday lenders have an interesting profile - with some surprising assets. For example, payday borrowers are bank customers. More than 40% of the payday borrowers own their own homes. They are someone's mortgage customer.

The typical payday borrower is on a very tight budget and checking account balances routinely drop to less than $50.00. The typical borrower is well aware of the consequences of bouncing a check or failing to make a timely payment on a credit card. These customers seek payday loans to avoid the adverse consequences from their financial institution.

Predatory Lending?
In the current environment of concern about the consumer harm from predatory lending, payday lending is highly controversial. Opponents express concern about outrageous APRs, limited options on repayment, possible conversion of fees to principle, and similar practices that could lead a consumer into an irreversible cycle of debt.

State regulators are concerned that national banks may be renting their charters to payday lenders and profiting from the "rental." This enables payday lenders to dodge state regulation and state usury rates.

Consumer advocates are concerned that relationships between financial institutions and payday lenders may result in steering the consumer to the more profitable and more costly payday product.

The common denominator to these concerns is the difficult miss or match between credit needs, credit products, and mutual benefit. To avoid the label of predatory lending, the credit product should be beneficial to the consumer as well as profitable to the lender.

Payday Loan Alternatives
Customers who take out payday loans do so because their options are limited and the payday loan may be the most attractive alternative.

Overdraft privileges are a logical alternative. However, the average balance in a payday customer's checking account is usually too low to qualify for affordable overdraft privileges. In addition, some overdraft programs - especially those that impose a per-item fee and daily charges - are at least as expensive to the consumer as the payday loans.

A second alternative is a short-term loan. However, most financial institutions don't offer loans of such a low amount and for such a short term. As a result, although the bank loan's APR may be much lower, the actual loan cost to the consumer may be greater.Credit cards, a third alternative, may be maxed or the payday loan may be needed to avoid a $29 late payment charge and/or an increase in interest rate. $17.25 for the payday loan is less than the late payment charge on a credit card.

Employment-based credit unions and community development credit unions tend to offer the most affordable alternatives. These, however, being based on membership, provide alternatives for only some consumers.

Varma suggested several alternative credit programs including low-cost loans administered through neighborhood churches. Such programs could provide community investment opportunities for financial institutions.

Varma also stressed the need for increased regulation of the payday lending industry, from both state and federal regulators. She would like to see rate regulation to protect borrowers. Finally, she believes that increased consumer information and financial education is key to avoiding predatory lending consequences.

Self-regulation
Due to its controversial nature, a large component of the industry has developed and adopted a Best Practices standard. Webster, a past president of the Community Financial Services Association of America, was instrumental in having these best practices developed and in implementing a self-enforcement vehicle. All members of the association must comply with the best practices or be expelled from membership.

Best practices include: full disclosure, compliance with applicable state and federal laws including laws relating to fees and rollovers, truthful advertising, encouraging consumer responsibility, providing a one-day right to rescind at no cost to the borrower, compliance with the FDCPA, self-policing, and development of constructive relationships with financial institutions.

Conclusions
There is clearly a credit need for low-balance loans that is not being met by financial institutions. Those needing the service range from credit-worthy customers with limited financial options to consumers who actually lack the ability to repay. There are opportunities for financial institutions, as is demonstrated by the success of the payday lending industry. Cost-effective products that serve consumer needs could be an important part of an institution's CRA program. This will also involve some experimentation with cost structure that will benefit both borrower and lender. Ultimately, the most important activity a financial institution can offer is financial education so that consumers adequately understand their options. You should be asking yourself some hard questions about whether and how your institution can find an effective way to meet this credit need.

ACTION STEPS

Take a careful look at your market to find out what other types of creditors are there.
Now take a hard look at the customer bases of non-financial institution creditors. If finance companies, payday lenders, and check cashers are doing a thriving business, you are missing an opportunity.
Evaluate your branch locations and compare them to the locations of check cashers and payday lenders to identify possible locations for offering financial services.
Review your overdraft products and procedures. Your best opportunity for competing with payday lenders may be with an overdraft product that is fairly priced.
Talk with your front-line branch staff to learn about customer requests and concerns.
Provide financial education in your community.