Following previous guidance issued by (and in some cases withdrawn by) the OCC, CFPB, Federal Reserve, FDIC, and NCUA, the federal financial institution regulatory agencies published a joint statement on March 26, 2020, in response to COVID-19 “to specifically encourage financial institutions to offer responsible small-dollar loans to both consumers and small businesses.” The statement is somewhat confusing given the “love/hate” history of regulators with regard to businesses in the small-dollar lending space. However, much needed new interagency lending principles for offering responsible small-dollar loans was issued on May 20, 2020 (the “Interagency Guidelines”) to clarify regulatory expectations.
Recognizing the potential for COVID-19 to adversely affect the operations and customers of financial institutions and the “important role” responsible small-dollar lending can play in helping consumers meet credit needs in times of disaster recovery or economic stress, the statement noted that “[f]ederally supervised financial institutions are well-suited to meet the credit needs of customers affected by the current COVID-19 emergency.” To that end, the agencies noted that products offered by financial institutions could potentially be modified to meet consumers’ credit needs in conformity with applicable laws and regulations.
The statement also noted that financial institutions may offer responsible small-dollar loans under current regulatory framework through various loan products, including closed-end installment loans, open-end lines of credit, or single payment loans, for example. In addition, the statement encourages financial institutions to “consider workout strategies designed to help enable the borrower to repay the principal of the loan while mitigating the need to re-borrow” for borrowers who may not be able to repay a loan as structured due to unexpected circumstances.
Importantly, the agencies recognized in the statement that responsible small-dollar loans can be beneficial to customers even in normal times, such as when unexpected expenses or temporary income short-falls arise. However, given conflicting issues with prior guidance in this space, future guidance and lending principles for what the agencies call “responsible” small-dollar loans were needed and recently delivered by the agencies.
The new Interagency Guidelines, unlike the statement, articulate principles for offering small-dollar loans in a “responsible manner to meet financial institutions customers’ short-term credit needs” through interagency guidelines to encourage supervised banks, savings associations, and credit unions to offer responsible small-dollar loans to customers for consumer and for small business purposes. The Interagency Guidelines gave insight on what regulators deem to be responsible small-dollar loan programs, which generally contain a high percentage of customers who are successful in repaying their loans, repayment terms, pricing, and safeguards that minimize “cycles of debt” such as rollovers and reborrowing, and repayment outcomes and program structures that enhance a customer’s financial capabilities. However, they also stated that financial institutions seeking to develop new small-dollar lending programs or expand existing programs should do so in a manner consistent with sound risk management principles, inclusive of appropriate policies. This may prove challenging as small-dollar loans often have high default rates and need a higher interest rate in order to be profitable, which may not be possible due to certain state law restrictions. These and other issues likely will prove challenging for the required sound risk management analysis and other bank policies.
The Interagency Guidelines further outlined the items that reasonable loan policies and sound risk management practices and controls would address. These include: (1) loan amounts and repayment terms that align with eligibility and underwriting criteria that promote fair treatment and credit access; (2) loan pricing that complies with applicable laws and reasonably relates to the lender’s risks and costs; (3) loan underwriting analysis that uses internal and/or external data sources, such as deposit account activity, to assess creditworthiness; (4) marketing and disclosures that comply with consumer protection laws and provide information in a clear, conspicuous, accurate, and customer-friendly manner; and (5) loan servicing processes that help ensure successful loan repayment and avoid continuous cycles of debt, including timely and reasonable workout strategies.
Interestingly, there was commentary in the Interagency Guidelines on using innovative technology and/or processes for customers who may not meet a financial institution’s traditional underwriting standards. This commentary further stated that such programs can be implemented in-house or through effectively managed third-party relationships. This commentary may help take some pressure off the bank partnership model in the area of small-dollar lending, quieting the critics and signaling a change that bank and fintech partnerships that offer sound and responsible innovative products to customers are here to stay.
The statement has drawn the ire of consumer advocates who believe these loans could trap people in a cycle of repeat re-borrowing at high rates. While the Interagency Guidelines certainly help clarify many issues for financial institutions and small-dollar lending, there are still some challenges and small-dollar lenders are advised to consult counsel for guidance regarding how the Interagency Guidelines will be implemented in practice.
