For decades, federal regulators and policy makers have grappled with how to foster credit inclusion to the financially underserved. Many programs were developed with little success. The Federal Deposit Insurance Corporation launched a now-defunct small dollar loan program in 2008 with marginal results. A few years later, the National Credit Union Administration began allowing credit unions to offer Payday Alternative Loans (PAL) in 2010. After nearly a decade however, PALs serve an anemic 0.2 percent of the $90 billion short-term, small-dollar market. With 38 million Americans having a non-prime FICO score below 600, none benefit from the now-defunct FDIC program, and only a fraction of them benefit from the PAL program. Fintech firms, and all the disruptive innovation they bring with them, provide a chance at financial inclusion for these non-prime consumers.
Over the last five years, there has been dramatic improvement in bank and non-bank offerings to consumers with less-than-prime credit scores. The Financial Health Network released a new study looking at the types of credit products “financially underserved” were using. The report found that bank overdrafts and pawn shops have stagnated while payday loans have declined significantly in recent years. Instead, consumers are increasing their use of installment loans, which has a compound annual growth rate of nearly 14 percent annually between 2015 and 2018. They estimate installment loans rose by 12.4 percent over the last year alone.
So, what is happening? Well, first several states like Florida, Oklahoma and Ohio have joined other states in adopting new installment loan laws to allow for 10-18 percent per month pricing structures which expands lending to risk-based, non-prime borrowers. Second, Fintech non-bank lenders have leveraged their technology and expertise to introduce new pricing structures that reflect the risk profile of a borrower. Products like NetCredit, OppLoans and Elastic have much lower pricing options and flexible terms than a single term payday loan. Third, these Fintech firms have also created a new vertical market by selling their technology and know-how to banks. Banks are increasingly partnering with Fintech firms to innovate and serve consumers that have been historically out of reach.
Both fintech firms and banks have much to gain and little to lose by collaborating. The benefit to banks is exponential. By tapping into expertise, traditional banks stand to move more swiftly and effectively to introduce new products and enhance a customer experience. Banks routinely make loans with the assistance of third-party service providers. Partnering with new fintech firms has benefited consumers the most by providing them the opportunity with access to credit by FDIC-regulated institutions.
Even large traditional banks have begun to develop smaller dollar installment loan products. U.S. Bank introduced Simple Loan last year, which is offered to existing customers with direct deposit. Loans have an interest rate of 6-7 percent per month.
Despite these new gains towards credit inclusion, there is a congressional proposal that will take the non-prime consumer back to the dark ages. It would establish a 36 percent APR national rate cap, limiting interest rates to only 3 percent per month. This rate cap will permanently ban the non-prime consumer from the credit market. Economic data consistently demonstrates that rate caps reduce, if not eliminate, access to credit for non-prime consumers, leaving consumers with fewer financial options.
The Military Lending Act is touted as a national template to protect consumers. However, two independent Harris Polls indicate that service members are financially worse off with MLA. In addition, a 2017 study by the U.S. Military Academy at West Point found that many of the short-term, small-dollar loan products that were outlawed under MLA had “few adverse effects” on military service members. In fact, the study stated that payday loan access may actually decrease “the probability of being involuntarily separated from the Army by 10 percent.”
For the first time non-prime consumers are part of the fintech inclusion revolution and many have described their experience as “convenient, lifesaving, trustworthy, grateful and thankful.” Inclusion can be real if we let innovation and data drive progress.
Mary Jackson is CEO of the Online Lenders Alliance (OLA).
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