Newswise — Banks and credit unions can make money and help their low- and middle-income customers by offering lower cost alternatives to high-fee payday loans, according to Sheila Bair, a professor at the University of Massachusetts Amherst and author of the report, "Low Cost Payday Loans: Opportunities and Obstacles." The study was funded by the Annie E. Casey Foundation in Baltimore.
"Payday loans are an extremely high-cost form of short-term credit," Bair says. "The high fees are exacerbated by many borrowers using the product 10 to 12 times a year. They are used predominantly by those who can least afford them."
Several factors make it economically viable for banks and credit unions to offer alternatives to payday loans, Bair says. Banks and credit unions already have the offices, loan staff and collection mechanisms, and they can minimize credit losses through the use of direct deposit and automatic deductions for repayment. They can also offer small-dollar credit at lower margins because they offer a wide variety of banking products and services. Revolving credit lines offered by banks and credit unions provide convenience, greater privacy and speed for the customer, compared to payday loans, the report says.
Payday loans are short-term loans of small amounts, generally less than $500. The loans are secured by the borrower's personal check and post-dated until the borrower's next payday. Typically, the cost ranges from $15 to $22 per $100 for a two-week loan, which works out to an expensive annualized percentage rate (APR) of 391 to 572 percent.
Under the current system, when a customer borrows $300, and the charge is $15 per $100 of loan, the customer writes a check for $345. The lender agrees to defer deposit of the check until the customer's next payday.
Payday lending has grown explosively in recent years. Last year (2004), 22,000 payday loan stores nationwide extended about $40 billion in short-term loans. Most borrowers " 52 percent " make between $25,000 and $50,000 per year, and 29 percent earn less than $25,000 a year.
The biggest impediment to low-cost payday alternatives, the report says, is the proliferation of fee-based bounce protection programs. "So many banks rely on bounce protection to cover customers' overdrafts for fees ranging from $17 to $35 per overdraft that they don't want to cannibalize profits by offering customers other low-cost options," says Bair.
Other barriers preventing banks and credit unions from entering this market include the stigma associated with offering small dollar loans, and the misperception that federal banking regulators are hostile to the idea. "On the contrary, our research shows that regulators view low-cost, properly structured payday loan alternatives as positive and likely warranting credit under the Community Reinvestment Act," says Bair. "We recommend that regulators step up to the plate and publicly encourage payday alternatives."
The report describes several examples of profitable payday loan alternatives. The best model, says Bair, is the North Carolina State Employees' Credit Union (NCSECU), which since 2001 has offered customers a checking account linked to a revolving line of credit. It charges an APR of 12 percent, or $5 for a $500, 30-day loan. It also requires borrowers to save 5 percent of any money borrowed and place it in a savings account. After 18 months, this program generated more than $6 million in cumulative savings.
Another good model is the Citibank Checking Plus program, which is a revolving line of credit linked to a customer's checking account, offered at a 17 percent APR. "This product can be used by low- and middle-income families to meet short-term emergency cash needs," Bair says. Other recommendations include:
-- The Federal Reserve Board should require banks and credit unions to disclose the cost of fee-based bounce protection to customers who use it on a recurring basis. This would help consumers understand the real cost and strengthen the institutions that offer competing lower cost options.
-- Banks and credit unions should combine small dollar products with mandatory savings features to help customers accumulate savings.
Copies of the report are available at: http://www.aecf.org/publications/data/payday_loans.pdf
Editor's note: Bair will discuss this report on Sept. 29 at a conference in Washington, D.C., hosted by the Federal Deposit Insurance Corporation. FDIC Director Tom Curry, a former Massachusetts banking commissioner, will also speak at the conference.
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