Wednesday, August 31, 2011

Regulators and the Underbanked

What can banking industry regulators do about payday lending and other predatory products of so the called alternative financial service providers? In most States, not much, unfortunately. National regulators such as the Office of Controller of the Currency (OCC), the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) have no remit to regulate these non-bank purveyors of dubious financial services. The new Consumer Financial Protection Bureau which was established as part of the recent Dodd-Frank financial reform bill, can only act to control the payday lending industry with the approval of individual state regulatory entities.

With the economy continuing to linger in the doldrums of a jobless recovery, a majority of Americans appear unable to meet a $1,000 emergency expense. According to a recent report by the National Foundation for Credit Counseling only 36% of American households have the funds available to meeting an expense of this modest magnitude. No wonder the business of the payday lenders is booming and some commercial banks are beginning to offer their own payday-style products.

So-called “direct-deposit advance” loans are increasingly being used by low-income consumers with bank accounts linked to some form of direct deposit like a paycheck or social security benefit. Much like the payday loan, they are for a short duration and come with effective triple digit interest rates. Although they are less expensive than the typical payday loan, consumer advocates argue that they still lead to crippling dependency on debt. In fact, the Center for Responsible Lending urges regulators to immediately stop the banks they supervise from making such loans.

But would this really be helpful? After all, low income consumers do need the money and the bank product is arguably better than that offered by the alternative financial service providers. Would not such regulatory action simply drive these borrowers in greater number to the more predatory lenders. Instead of prohibiting banks from offering short-term, payday-style credit, why not require them to offer a product that meets the consumers’ needs and helps them to manage their debt needs responsibly?

Market purists would argue that banks should take such action on their own and this would be one more example of over intrusive government regulation. But the opportunity for short-term gain often trumps sound long-term corporate strategy. The subprime lending crisis that largely precipitated and certainly exacerbated the current economic crisis is ample evidence of this. And who would argue that stringent, government mandated warnings on the dangers smoking hasn’t induced large segments of the population to give up very harmful behavior?

In fact, regulators already have a tool, the Community Reinvestment Act, sufficient to encourage and reward banks for lending more responsibly to low income communities. As I reported in my previous blog post, Emerge Workplace Solutions, a for-profit social venture works with employers and mainstream financial institutions to provide financial wellness coaching and credit products that help workers re-build rather than destroy their credit. And now Citibank is pioneering with the Center for Community Self-Help in developing a “Micro Branch” model to compete with payday lenders in low-income communities.

Until we can outlaw the underlying need in low income communities for short-term credit it makes no sense to prohibit mainstream banks from providing it. However, we can and must ensure that this need is met in a way that alleviates rather than causes greater poverty.