With the stimulus in legislative limbo, the market could see an increase in low-value loans

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As lawmakers wrangle the future of stimulus payments and unemployment benefits, cash-strapped consumers may be forced to turn to credit products to meet upcoming spending.

Among at-risk consumers who make up about a third of the US population, options are limited, with many resorting to high-cost payday loans. In recent months, however, regulators have urged banks to enter the low dollar lending market to help customers negatively affected by the pandemic.

Despite the push, only a handful of banks are offering low-value loans. Space banks say they can offer them cost-effectively and can deepen customer relationships as credit scores improve.

“Our customers are definitely having disruption in their income and they have unforeseen expenses,” said Mike Shepard, senior vice president of consumer loans at US Bank, which has been offering small loans for two years. “Some are living on the edge, and a product like Simple Loan has absolutely been seen as a viable positive option.”

Small loans are generally less than $ 5,000 and paid in installments. Banks that play in this field fall into two camps: those that offer small loans directly, such as US Bank and KeyBank, and others that offer them in partnership with service providers and subprime lenders.

FinWise Bank belongs to the latter category. The Murray, Utah-based lender, who jumped into the business two years ago, suggested small loans could be solutions to consumers’ unexpected financial woes.

“We wanted to make sure that the products we were offering were products that could help someone move forward on their credit journey instead of keeping them stuck and trapped,” said Kent Landvatter, CEO of FinWise.

Fee structure

Banks that offer small loans generate income from fees, but depending on their service model, they take different approaches to reaching customers.

A US Bank Simple Loan is more expensive than a credit card but cheaper than a payday loan. Customers can borrow up to $ 1,000 in $ 100 increments. Customers have three months to pay it off, and for every $ 100 borrowed, they’re charged $ 12 for automatic payments and $ 15 if they make manual payments. So, if a customer borrows $ 400 and chooses automatic payments, they will pay off $ 448 in three monthly installments of approximately $ 149.33 each, which equates to an Annual Percentage Rate (APR) of 70.65%.

US Bank sets a limit on monthly payments at 5% of a consumer’s income as a safety guard. Customers accessing the product must be US Bank customers and are assessed based on their cash flow, income, and credit profile details. The US bank said it could offer these loans cost effectively due to the low overhead and lower risk associated with offering the product to existing customers.

“This is a completely digital product; no one is involved in the underwriting of the decisions,” Shepard said. “By only offering this to US bank customers, we have knowledge and insights into the larger relationship that helps us make a better decision.”

In contrast, small loans offered by FinWise through partners generally have higher APRs. For example, OppLoans, a provider that partners with FinWise and Salt Lake City-based First Electronic Bank, can lend to customers in Ohio, say, between $ 500 and $ 4,000, with repayment terms that last nine to 18 months. The APR for these loans is 160%, according to the company’s website, exceeding the maximum loan amount and the highest interest rate that payday lenders are allowed to offer under the laws of the. State.

A distinction needs to be made between low dollar loans that banks offer to their own customers and those offered by banks in partnership with service providers and subprime lenders, said Alex Horowitz, head of research at Pew Charitable. Trusts. The latter arrangement exposes consumers to higher fees and fewer guarantees, he said.

“The loans they give are basically payday loans,” Horowitz said. “Banks have special privileges that payday lenders do not have, where they can export interest rates from their home country – [the loans] are priced high enough that they are illegal under state law. “

Despite the high interest rates, OppLoans retorts that products offered through its platform and licensed by partner institutions are reaching a market segment outside the traditional credit spectrum.

“We work as an outsourced supplier and provide access to this segment of the market, which has historically been underserved by traditional players and essentially all of the big banks,” said Jared Kaplan, CEO of OppLoans. “They’re not looking at traditional credit scoring; they’re looking at alternative data and banking behavior, to measure a consumer’s ability and willingness to repay.”

Plus, customers can improve their credit score by making payments on time, which qualifies them for lower-cost products over time, Landvatter said.

A relational game

Both FinWise and US Bank have said they see low dollar lending products as opportunities to improve customer relationships. The two institutions, without offering figures, said demand for the products had not increased during the pandemic, in part due to increased unemployment benefits and stimulus payments.

“The demand for the product has actually declined, and this is in part because a combination of consumers are spending less, and there has been an influx of capital into the checking accounts of many consumers as a result of the actions taken by government, ”Shepard said. .

FinWise said demand has remained constant throughout the pandemic, with no increase in defaults or charges.

As institutions assess consumers’ needs for low dollar credit after the end of economic impact payments, offering low dollar loans could help institutions build customer confidence and encourage them to adopt other products at the same time. over time, analysts said.

“It won’t be a huge money generator for the banks,” said Leslie Parrish, senior analyst at Aite Group. “If there is a potential acceleration or creation of goodwill, that will be the benefits for the bank.”

Four regulators – Federal Reserve, Federal Deposit Insurance Corp. (FDIC), Office of the Comptroller of the Currency (OCC), and National Credit Union Administration (NCUA) – released guidelines in May to guide banks offering small loans.

Despite this green light, the banks have not fully deployed their products. Practitioners cite the potential for regulatory changes after the next election, as well as questions about how banks can cost-effectively offer these products, as reasons such an effort has not been successful.

“Even with the encouragement and guidance from regulators, banks have yet to find a way to make the economy work,” Doug Farry, co-founder of Employee Loan Solutions, told American Banker in July.

The entry of fintechs into low dollar lending is also adding competitive pressure, with recent reports from Square testing low dollar loans offered through its peer-to-peer Cash app. Nonetheless, Pew’s Horowitz suggested that banks and credit unions are well positioned to be successful in this market because they have no acquisition costs, they can underwrite depending on activity and deposit history. customers, and they lack significant overheads. He also said there could be a lag – the time it takes for banks to test products – between the May forecast and the release of loan products into the market.

For its part, the U.S. bank said it expects demand for the product to eventually reach pre-pandemic levels.

“Outside of the last four or five months, the demand has been very constant,” Shepard said. “I would expect that when we get to what this new form of normalcy looks like, we’ll come back to a pretty consistent volume that we’ve seen historically.”

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