A Little Regulation Can Go A Long Way: Protecting Those Vulnerable to Predatory Lending

Yesterday’s post concerned the efforts of the House Republicans to de-regulate the payday lending industry in the guise of H.R. 6139.  With nearly a third of Las Vegas, NV individuals availing themselves of high interest short term loans the problem of predatory lending deserves more than a passing critique of an individual piece of legislation.  Additionally, if we truly believe the function of government is to protect its citizens, then the de-regulation of the high interest lenders stands in high contrast to that goal.

This isn’t a call for a nanny state, it’s more like an extension of the point made by President Reagan: “Government exists to protect us from each other. Where government has gone beyond its limits is in deciding to protect us from ourselves.”  Predatory lending practices definitely fit in the former category.

With this in mind, who are the targets of high interest lenders?

The targets are the unbanked and the underbanked:The highest unbanked and underbanked rates are found among non-Asian minorities, lower-income households, younger households, and unemployed households. Close to half of all households in these groups are unbanked or underbanked compared to slightly more than one-quarter of all households.”  [FDIC pdf]

Those who are unbanked are families in which no one has a checking or savings account; the underbanked are families in which there might be a small savings and checking account, but financial needs are augmented by non-bank money orders, check cashing services, rent to own firms, RAL’s (refund anticipation loans), and pawn shop services.

The Federal Deposit Insurance Corporation found that the unbanked, and underbanked, are predominantly in ethnic minority communities.

As the FDIC graph indicates, those likely to fall into the unbanked and under-banked categories are predominantly Hispanic and African American.

The unbanked and under-banked also tend to be low income, and low education.

And, there’s no surprise here… most of the unbanked and under-banked are younger people.

Fully 57.5% of the unbanked are under the age of 44, with 37.3% under the age of 34.   11.1% of the unbanked are new to the work force, aged 15-24 years of age, and 8.1% of the under-banked are 15 to 24.

The unremarkable conclusion is easily reached: Those who are most likely to fall prey to predatory high interest lending are young, minority group individuals, with lower rates of educational attainment.  The vulnerable at risk of running into the vultures.

Advocates of “alternative banking” complain that since the high interest rate lenders deal with higher risk borrowers they must, of necessity, charge higher rates to cover their risk of default.  No one would make a sound argument based on an inversion of the risk and reward model of consumer lending.  However, the amount required to cover potential expenses doesn’t automatically justify rates which might make a loan shark lose his appetite.

The argument that making many small loans incurs more cost than making fewer larger loans founders on the same shoals.

Pilot Whales and Loan Sharks

In February 2008 the FDIC launched a pilot program with 28 volunteer banks to offer small dollar loans with restrictions on interest rates and provisions.
The agency reported: “Since the pilot began, participating banks made more than 34,400 small-dollar loans with a principal balance of $40.2 million. The pilot tracked two types of loans: small-dollar loans (SDLs) of $1,000 or less and nearly small-dollar loans (NSDLs) between $1,000 and $2,500. All pilot banks offered only closed end installment loans.”   The FDIC used initial information to produce a template for small and nearly small dollar loans:

The Pay Day lending lobbyists promptly dismissed the FDIC’s efforts as too little (only 31 banks participating) and insufficiently differentiated from pay day lending.  The critique failed to note the program was a PILOT project to create templates for the banking sector and not an attempt to initiate a broad banking program for the unbanked and under-banked.   Also missing from the criticism was the information that the pilot program yielded results necessary to create banking guidelines for small dollar loans.

“In June 2007, the FDIC issued the Affordable Small Dollar Loan Guidelines (Guidelines) to encourage financial institutions to offer small-dollar credit products that are affordable, yet safe and sound, and consistent with all applicable federal and state laws.”  [FDIC]

What the FDIC discovered in the course of its pilot project was that regulated banks could issue small dollar loans, which didn’t break either the lender or the borrower, and which didn’t involve stretching — or avoiding — federal and state consumer protections.

And, still protect the vulnerable from the vultures.

For further informationFDIC, “2011 FDIC National Survey of Unbanked and Underbanked Households,” pdf.   FDIC Small Dollar Loan Pilot Program.

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