On May 20, 2020, the Federal Reserve Board (“FRB”), the Federal Deposit Insurance Corporation (“FDIC”), the Office of the Comptroller of the Currency (“OCC”), and the National Credit Union Administration (“NCUA”) (together, the “Agencies”) released joint principles intended to encourage supervised banks, savings associations, and credit unions to offer responsible small-dollar loans to both consumers and small businesses (“Joint Principles”). The Joint Principles unify recent, differing approaches taken so far by each Agency in an effort to foster the offering of small-dollar credit products by supervised financial institutions. Rather than introducing prescriptive rules, the Agencies adopted a uniform lending framework designed to give financial institutions discretion in structuring “well-designed” small-dollar lending programs without running afoul of safety and soundness standards and consumer protection laws.
The release of the Joint Principles is the latest effort by the Agencies to override years of policy seeking to actively discourage banks and credit unions from engaging in small-dollar lending. This new release follows a recent, more targeted interagency statement issued by the Agencies and the Consumer Financial Protection Bureau (“CFPB”) on March 26, 2020, which urged supervised financial institutions to start offering small-dollar loans to customers facing financial hardship from the COVID-19 outbreak.1
Frowned upon by federal banking regulators during the Obama administration, banks and credit unions have largely steered clear of the small-dollar lending market in the last decade. In November 2013, the OCC and the FDIC effectively banned deposit advance products by making it impractical or undesirable for banks to provide, or continue to provide, such services (“2013 Guidance”).2 Defined as small-dollar, short-term lines of credit made available to bank customers with established checking account relationships, deposit advance products often carried high fees and interest rates, which the regulators viewed as inconsistent with safety and soundness and consumer protection principles.
Trump-appointed federal regulators, however, have tilted in the opposite direction, stressing that banks and credit unions are “well-suited” to meet the ongoing credit needs of customers experiencing unexpected or temporary income shortfalls. In October 2017, the OCC rescinded the 2013 Guidance3 and, in May 2018, the agency formally invited national banks and federal savings associations to compete with short-term, small-dollar nonbank lenders, thereby pivoting away from its previous stance.4 By contrast, the FDIC allowed its 2013 Guidance to remain in place and instead requested industry input on steps it could take “to encourage FDIC-supervised institutions to offer responsible, prudently underwritten small-dollar credit products that are economically viable and address the credit needs of bank customers.”5 In September 2019, the NCUA also released a final rule establishing a new type of payday alternative loans that federal credit unions may offer to their members.6
In response to the COVID-19 pandemic, the Agencies recently released a series of statements instructing supervised financial institutions to work with customers experiencing financial hardship,7 including by offering responsible small-dollar loans to the extent these provide fair treatment of customers, comply with applicable laws and regulations, and are consistent with safe and sound banking practices.8 The Joint Principles build upon these prior statements and aim to provide uniform small-dollar lending guidelines applicable to all supervised financial institutions.
The Joint Principles: Overview
The Agencies clarified that the current regulatory framework does not preclude banks and other lenders from offering a broad range of small-dollar credit products, including open-end lines of credit, closed-end installment loans, or shorter-term structured single-payment loans, subject to safety and soundness principles and consumer protection laws. The Joint Principles, however, do not apply to credit cards or bank overdraft programs, which provide another source of short-term liquidity to customers.
Financial institutions seeking to develop or expand their existing small-dollar lending programs must do so “responsibly,” with an emphasis on ensuring that borrowers are able to repay the loans. In effect, the Agencies stressed that a “responsible” and “well-designed” small-dollar lending program is one that reflects the following characteristics:
|A high percentage of customers successfully repaying their small-dollar loans in accordance with original loan terms, which is a key indicator of affordability, eligibility, and appropriate underwriting
||Repayment terms and features that minimize adverse customer outcomes, including cycles of debt due to rollovers or re-borrowing
||Repayment outcomes and program structures that enhance a borrower’s financial capabilities
The Agencies, however, remain flexible as to the approaches that financial institutions may take in developing a responsible small-dollar lending program and clarified that such program may be implemented in-house or through third-party relationships to the extent compliant with applicable third-party risk management principles. The Agencies also encourage lenders to leverage innovative technology and to use alternative data sources to assess borrowers’ creditworthiness in order to lower underwriting costs and reach consumers not otherwise captured by banks’ traditional underwriting standards. This position is consistent with a prior interagency statement that recognized the benefits of using alternative data in credit underwriting. 9
In addition, the Agencies emphasized the importance of maintaining prudent loan policies and sound risk management practices that permit financial institutions to identify, monitor, manage, and control the risks inherent to small-dollar lending. Specifically, the Joint Principles provide the following three core lending principles when offering small-dollar loan products:
|Loan products are consistent with safe and sound banking, treat customers fairly, and comply with applicable laws and regulations, including fair lending laws
||Financial institutions effectively manage the risks associated with the products they offer, including credit, operational and compliance
||Loan products are underwritten based on prudent policies and practices governing the amounts borrowed, frequency of borrowing and repayment requirements
Prudent lending policies and risk management practices are also expected to address loan structures, pricing, underwriting, marketing and disclosures, along with servicing and safeguards for customers who may find themselves experiencing hardship or unexpected circumstances.
The Joint Principles are consistent with the Agencies’ recent shift away from the Obama-era policy designed to curtail access to small-dollar loans and follow close on the heels of a more general guidance that encouraged financial institutions to offer responsible small-dollar loans to customers affected by the COVID-19 pandemic. We note the following key considerations:
- Encouraging safe and responsible small-dollar lending. Rather than prescribing a set of prescriptive rules, the Agencies opted for broader lending principles designed to give financial institutions more latitude when implementing a responsible small-dollar lending program. Short of introducing more concrete restrictions, such as a cap on interest rates for small-dollar credit products, consumer advocates cautioned that the Joint Principles may encourage banks and credit unions to offer high-cost loans at a time that consumers and small businesses are most vulnerable. Of note, the Joint Principles do not bar deposit advance products and other types of “shorter-term single payment structures,” which consumer advocates view as having the potential to create high-cost debt cycles. Language used by the Agencies, however, suggests that lenders only have a green light to offer safer, small-dollar credit products that borrowers can successfully repay within a reasonable timeframe without having to re-borrow. Similarly, the Agencies expect that loan pricing be “reasonably related to the financial institution’s risks and costs,” suggesting that loans that cost little to originate and/or present little risks to the lender should not carry high interest rates.
- Promoting well-managed bank-nonbank partnerships. The Joint Principles also signal a more favorable posture toward third-party arrangements to implement small-dollar lending programs. To the extent compliant with applicable third-party risk management principles, the Agencies welcome effectively managed bank-nonbank partnerships involving, for instance, the making and/or servicing of small-dollar credit products. Financial institutions are also encouraged to leverage innovative technology and alternative underwriting processes developed by third-party relationships to manage credit risk, lower costs and reach borrowers not otherwise captured by traditional scoring models. Financial institutions should, however, carefully review applicable risk management and supervisory expectations before entering into third-party arrangements.
- Fostering competition in the small-dollar lending market. The Joint Principles formally invite banks to compete with payday and other alternative lenders. It remains unclear, however, whether banks will be able to underwrite responsible small-dollar loans cost-effectively to compete with less regulated payday lenders. The lack of prescriptive rules or specific guidelines in the Joint Principles, such as appropriate loan terms, rate limits and fee structures, may also discourage certain banks from entering into the small-dollar credit market out of supervisory concerns. At the same time, several states, such as California, Colorado and Virginia, have ramped up their efforts in recent years to cap interest rates charged on short-term credit products and other payday loans. The CFPB also announced that it would issue its revised Payday, Vehicle Title, and Certain High-Cost Installment Loans (“Payday Rule”)10 in the very near future. While the CFPB elected to rescind the more onerous underwriting provisions included in the original version of the Payday Rule, the revised rule nevertheless imposes new requirements and limitations on payday lenders with respect to attempts to withdraw loan payments from consumers’ bank accounts.11 These developments may ultimately make it unprofitable for certain lenders to stay in business at a time when consumers experience unexpected expenses or income shortfalls due to the COVID-19 public health emergency. The Joint Principles, paired with a high demand for short-term liquidity, may provide the required impetus for banks and credit unions to start offering small-dollar credit products.
The Joint Principles provide a unified framework for banks and credit unions to offer small-dollar loans safely and responsibly to consumer and small businesses. Increased regulatory clarity paired with a high demand for short-term liquidity in light of the ongoing health emergency are expected to prompt financial institutions to enter the small-dollar lending market. In evaluating what types of small-dollar credit products to offer, banks and credit unions should first carefully review the Joint Principles and, when appropriate, consult with their regulator.
1 Joint Statement Encouraging Responsible Small-Dollar Lending in Response to COVID-19 (Mar. 26, 2020), available at https://www.occ.gov/news-issuances/news-releases/2020/nr-ia-2020-40a.pdf.
2 FDIC and OCC, Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products, available at https://www.fdic.gov/news/news/press/2013/pr13105a.pdf.
3 OCC, Acting Comptroller of the Currency Rescinds Deposit Advance Product Guidance (Oct. 5, 2017), available at https://www.occ.treas.gov/news-issuances/news-releases/2017/nr-occ-2017-118.html.
4 OCC Bulletin 2018-14, Installment Lending: Core Lending Principles for Short-Term, Small-Dollar Installment Lending (May 23, 2018), available at https://www.occ.gov/static/rescinded-bulletins/bulletin-2018-14.pdf. OCC Bulletin 2018-14 has been rescinded and superseded by the Joint Principles.
5 FDIC, Request for Information on Small-Dollar Lending, RIN 3064-ZA04 (Nov. 20, 2018), available at https://www.govinfo.gov/content/pkg/FR-2018-11-20/pdf/2018-25257.pdf. The FDIC’s 2013 Guidance has been rescinded and superseded by the Joint Principles.
6 NCUA, Payday Alternative Loans, RIN 3133-AE84 (Sept. 19, 2019), available at https://www.ncua.gov/files/agenda-items/AG20190919Item4b.pdf.
7 See, e.g., Joint Press Release, Agencies Encourage Financial Institutions to Meet Financial Needs of Customers and Members Affected by Coronavirus (Mar. 9, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200309a.htm. For more information, please refer to White & Case’s Coronavirus Financial Regulatory and Legislative Dashboard, which provides periodic updates and insights as the COVID-19 crisis and the response develop.
8 Joint Statement Encouraging Responsible Small-Dollar Lending in Response to COVID-19 (Mar. 26, 2020), available at https://www.occ.gov/news-issuances/news-releases/2020/nr-ia-2020-40a.pdf.
9 Interagency Statement on the Use of Alternative Data in Credit Underwriting (Dec.3, 2019), available at https://www.occ.gov/news-issuances/news-releases/2019/nr-ia-2019-142a.pdf.
10 CFPB, Payday, Vehicle Title, and Certain High-Cost Installment Loans (Nov. 17, 2017), available at https://www.govinfo.gov/content/pkg/FR-2017-11-17/pdf/2017-21808.pdf.
11 CFPB, Vehicle Title, and Certain High-Cost Installment Loans (Feb. 6, 2019), available at https://files.consumerfinance.gov/f/documents/cfpb_payday_nprm-2019-reconsideration.pdf