5 Reasons Why You’re Not Offering Short-Term Loans. And Why You Should Reconsider.
Steve Swanston, Executive VP
- You don’t think your customers or members need it
Perhaps many of your locations are in affluent areas, or you believe that your account holders have access to other types of short-term liquidity. But the statistics regarding American personal finances may surprise you:
- Nearly 50% of American consumers lack the necessary savings to cover a $400 emergency¹.
- The personal savings rate dipped to 2.8% in April 2018, the lowest rate in over a decade².
- Each year 12 million Americans take out payday loans, spending $9 billion on loan fees3.
Based on these statistics, it’s likely that a portion of your customer or member base is affected by the lack of savings, or has a need for better access to liquidity, and chances are good that they’d be receptive to a small-dollar, short-term loan solution.
- It’s Cost and Resource Prohibitive
For most financial institutions, introducing a traditional small-dollar loan program is a cost-prohibitive process – not only operationally, but also from a staffing standpoint. From the cost of loan officers and underwriters to the overhead, the reality is that it would take time and resources that many banks and credit unions simply do not have.
Enter fintech firms, bringing proprietary technology and the application of big data. The right fintech partner can manage all the time, human and financial resources you may not have at your financial institution, such as application, underwriting and loan signing processes. And in some cases, the whole thing can be automated, resulting in a “self-service” program for your account holders, eliminating the human resource need!
- Underwriting Challenges and Charge Off Concerns
Another challenge you’re facing is the loan approval process and how to underwrite these unique loans. A determination of creditworthiness by a traditional credit check does not adequately predict the consumer’s current ability to repay using very recent behavior instead of patterns over a period of many years. Today’s fintech firms use proprietary technology to underwrite the loans, using methodology incorporating a variety of factors that will mitigate the incidence of charge offs.
In fact, the OCC recently released a bulletin outlining “reasonable policies and practices specific to short-term, small-dollar installment lending.” They stated that such policies would generally include “analysis that uses internal and external data sources, including deposit activity, to assess a consumer’s creditworthiness and to effectively manage credit risk4.” The right fintech partner will apply Big Data in such a way to assess creditworthiness using the OCC’s recommended criteria and a variety of other factors.
- Compliance Burdens
There’s no question that short-term loan options have been heavily regulated over the past eight years. The Dodd-Frank Act of 2010 resulted in the creation of the CFPB, which placed predatory lending and payday loans under scrutiny. In 2013, the OCC and FDIC released guidance that effectively ended banks’ payday loan alternative, the deposit advance. The CFPB cracked down even harder in October 2017 with their final payday lending rule, which packed the potential to devastate the storefront payday loan industry, forcing consumers to seek alternative sources of quick liquidity.
Flash forward to May 2018, and the pressure is easing. The OCC was the first to release a bulletin, encouraging banks to make responsible and efficient small-dollar loans. If history has taught us anything, it’s that the other regulatory agencies likely will soon follow suit.
- Concern About Cannibalizing Overdraft Revenue
At Velocity, we’ve worked with overdraft management programs for many years, and we’ve compiled extensive data around consumer overdraft behavior. Our data has shown that there are two distinct groups of consumers managing their liquidity needs in different ways:
These are consumers that struggle with transaction timing and incur overdraft or NSF fees as a result. A significant portion of this group might be managing irregular income streams, such as small business owners or commissioned salespeople. In many cases, these consumers are aware of their heavy overdraft activity, and have determined that the resulting overdraft fees are acceptable to them, and view overdraft as a valuable service. These consumers will continue to overdraft, because for them, it makes financial sense.
A second group includes those consumers who simply lack the cash to promptly pay their bills and either can’t obtain adequate overdraft limits or failed to opt-in to overdraft services. These consumers are actively seeking small-dollar loans to avoid the double whammy of hefty late fees and negative hits to their credit score for late payments.
Savvy financial institutions will ensure they have the programs in place to serve both groups of consumers, and fill the gap for the second category by using an automated small-dollar lending program with sound underwriting from a trusted fintech vendor.
¹Federal Reserve Board Press Release, “Federal Reserve Board issues Report on the Economic Well-Being of U.S. Households.”
²FRED® Economic Data, Personal Saving Rate: https://fred.stlouisfed.org/series/PSAVERT
³The Pew Charitable Trusts Press Release: CFPB’s Proposed Payday Loan Rule Misses Historic Opportunity, June 2016
4OCC BULLETIN 2018-14, “Core Lending Principles for Short-Term, Small-Dollar Installment Lending,” May 23, 2018