BIZMOLOGY — Federal regulators this week issued stern warnings to banks that offer payday style loans that typically carry high fees and often trap consumers in a cycle of debt.
The Office of the Comptroller of the Currency and the FDIC released guidance for banks that offer small-dollar, short-term loans such as deposit advances that are tied to paychecks or government benefits. The regulators are urging banks to better analyze borrowers’ ability to repay loans and monitor how often customers take out the loans.
Only a handful of large banks such as Wells Fargo and U.S. Bank offer payday loans, or similar products. Regions Bank recently scrapped plans to offer payday loans in North Carolina after consumer groups complained. Critics argue that the loans prey upon low-income people who often roll over the debt and end up borrowing the same amount or more multiple times. However, proponents say that the short-term loans fill a needed niche in the financial services industry.
Nearly one in four Americans have used payday loans, pawn shops, or other high-cost financing products, according to a report from the National Bureau of Economic Research. There remains a strong demand for small loans that help people make it to the next paycheck. With few other options, people who take out these loans are often desperate and willing to pay high fees for the extra cash. The annualized percentage rates on on a typical payday loan is more than 300 percent and the usual amount borrowed is about $350.
While this most recent round of proposed regulation is aimed at banks, nonbanks that offer payday loans also are on alert. Several states already have passed laws that cap interest rates on such loans. A few states have banned payday loans all together. Some online companies are springing up in more hospitable locations overseas. However, online competition for payday loans remains fragmented.
If banks are slapped with strict regulations on payday style loans and cease offering them, nonbanks could actually benefit as consumers continue to demand similar products. But nonbanks will likely be reined in as well. The newly formed Consumer Financial Protection Bureau, which has power to regulate nonbanks, recently released a report on payday loans and called them “debt traps.” It’s a big signal that the bureau plans to intervene.
Industry Impact
Banks and nonbanks that offer payday style loans face further regulation.
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Image by Helen Cobain used under a Creative Commons license