By William M. Isaac
It’s an honor to deliver this keynote address at the annual meeting of the Financial Services Centers of America (“FiSCA”). FiSCA represents some 6,000 licensed financial service center locations nationwide and these centers provide a broad range of much-needed products and services including: check cashing, prepaid cards with savings options, electronic bill payment services, installment loans and payday loans, wire transfers, vehicle title loans, metro transit cards, tax preparation and filing services, money orders, ATM access, debit card loads and withdrawals, and car license plates and titles pickup. Clearly, the convenient access to these services you provide is hugely important to tens of millions of working Americans.
These have been difficult times for many of you, particularly in light of an extremely hostile government environment at the federal level. Bank regulators, and more recently the Department of Justice with its Operation Chokepoint, have been forcing out of the banking system many companies offering small dollar loans, check cashing, and other services vital to working people. Each week more of your companies engaged in lawful business activities are cut off from access to check clearing, deposit accounts, and other routine banking services required to keep any company in operation.
I have been a relatively close observer of the struggles faced by non-bank consumer financial services companies (commonly referred to as “alternative financial services” companies) for over a decade dating back to when the Comptroller of the Currency decided to prohibit short-term or payday lenders from distributing their loans through national banks. I had some sympathy for the position of the Comptroller’s office with respect to the practice of “renting” a national bank charter to help non-banks avoid having to comply with state laws.
I did not interpret the Comptroller’s actions during that period as being an attack on short-term lending but as a measure to protect the ability of the Comptroller to pre-empt the states from regulating national banks. Right or wrong, the Comptroller made a policy judgment about what was in the best interests of the national banking system.
I believed a better outcome from the standpoint of consumers would have been for the federal bank regulators to allow – even encourage – banks to engage in short-term lending, check cashing, and other similar consumer products and services – not just through third-party vendor arrangements properly overseen, but also directly. That would have introduced more competition and better pricing for these services so desperately needed by low and middle income customers, particularly if accompanied by appropriate regulation.
To put this market need in perspective, let’s take a look at some key findings of the FDIC’s National Survey of Unbanked and Underbanked Households first published in December 2009 (the survey was updated in 2011 and the numbers of unbanked and underbanked grew larger):
- An estimated 7.7 percent of U.S. households (approximately 9 million households containing about 17 million adults) are unbanked.
- In addition to these unbanked households, 17.9 percent (approximately 21 million households containing 43 million adults) are underbanked.
- Taken together, 25.6 percent of U.S. households containing 60 million people are either unbanked or underbanked. The FDIC estimates the 60 million number is likely understated by 11 million.
- The percentage of unbanked and underbanked black, American Indian/Alaskan, and Hispanic households ranges from 43 percent to 54 percent.
- Households with earnings below $30,000 account for at least 71 percent of underbanked households.
- Two-thirds of unbanked households use alternative financial services such as non-bank money orders and non-bank check cashing services, payday loans, and other services provided by the people and firms in this audience. About one-quarter of these households do not use alternative financial services, suggesting a strong reliance on cash transactions.
- The FDIC survey indicates that most underbanked households that use alternative financial services do so primarily for convenience, speed of service, and ease in qualifying for a loan.
That was a lot of numbers, so let me highlight a couple that really paint the picture in terms of economic and societal needs. Roughly 71 million adults, or one quarter of the U.S. population, have limited or no participation in the banking system, which includes over half of black households, close to half of Hispanic and American Indian/Alaskan households, and over 70 percent of lower income households.
There are people in government (at the banking agencies, the Justice Department, the new Consumer Financial Protection Bureau, and on Capitol Hill) and in particular at various foundations and community organizations who rail against the products and services of alternative financial services companies, saying they are predatory and draw lower income people into a cycle of debt. While I believe most of these critics are well intentioned, I find it exceedingly frustrating that all many of them do is criticize and try to eliminate one of the most important financial life lines available to over 70 million working Americans.
I say to these critics, “If you have a better idea on how to address the financial needs of 70 million working class Americans, prove it. Show us your better idea, if you have one, and I will be the first to embrace it. In the meantime, until you demonstrate you have a better idea that will deliver necessary services to this large and growing segment of our population at attractive prices that allow a fair margin for profit, please stop trying to drive from business the lawful companies that are working night and day to serve this clear market need.”
Critics of the alternative financial services industry focus mostly on three issues. They argue that short-term or payday loans are too short and too costly and these two features combine to trap customers in an endless cycle of debt, thus leading to their conclusion that these loans are predatory.
It is very difficult for me to understand how a small, unsecured loan to a high-risk borrower can be predatory. If the borrower defaults, the lender has no collateral to go after and the loan is too small to justify legal action to collect. The only recourse the lender has is to refuse to make additional loans to that borrower.
Short term, unsecured consumer loans to borrowers with weak or limited credit histories are priced to cover the risks and operational costs of providing the service. The loans need to be relatively short term in order to limit the default risk. The typical payday loan is priced at a flat $15 per hundred dollar loan for two weeks. Critics point out that the Annual Percentage Rate on this loan exceeds 300 percent and call for short-term lenders to limit the APR to 36 percent.
To achieve a 36 percent APR, the lender would need to limit the fee on a two-week $100 loan to $1.38. While I believe that a more competitive marketplace will likely bring the price meaningfully below $15 per hundred over time, I can’t conceive of anyone willing or able to make $100 two-week unsecured loans to borrowers with poor or non-existent credit histories for anything close to a $1.38 fee.
The millions of people who use short-term, fixed-fee loans almost certainly know what’s in their own best interests better than anyone else. Payday loans appeal to people because they are convenient, easy to understand, and less expensive than the alternatives. For example, payday loans are usually less expensive than overdraft fees. They are less painful than the consequences of defaulting on an auto loan or a mortgage. And they are a better deal than having the electricity and heat turned off only later to pay fees for having them turned back on.
Research at the Federal Reserve Banks of New York and Kansas City both show that states that eliminate payday loans immediately experience a substantial rise in these costly outcomes. These studies also find more households file for bankruptcy when payday loans are no longer available.
Clearly, transparency to the borrower is very important. So are borrowers deceived by the terms of their payday loans? Research done at Columbia University indicates that most borrowers understand the terms of payday loans and are realistic about how long it will take to repay the loans and at what cost.
Payday loans are heavily regulated by the states. Some states ban them. Other states regulate the terms in various ways, including the allowable amounts. It’s not clear to me that we have done nearly enough research to determine which model is best and whether borrowers will be better protected by one federal model versus the many models used in the laboratory of states. Of one thing we can be certain – banning payday loans will lead to unintended and likely negative consequences for millions of working people.
Critics also attack check cashing services questioning why people should be charged seven or eight dollars to cash a payroll check, particularly when the check can be deposited in a bank account without a check cashing fee. Many people take their payroll check to a non-bank check cashing firm rather than depositing the check in their bank because they need the funds immediately, and their bank frequently will not release the funds for three or four days after it is deposited. They make the entirely reasonable judgment that having the cash in hand on Friday afternoon rather than the following Wednesday is important and worth seven dollars. Who are we to tell these people they are not capable of making that judgment?
Trade associations, such as FiSCA, have adopted model codes setting forth best practices for their members. The FiSCA code prescribes that its members hold active licenses in each state in which the member is doing business, protect the privacy of customer information, have proper disclosure of all fees, comply with the Fair Debt Collection Practices Act, manage vendor relationships to ensure compliance with laws and regulations, limit rollovers of payday loans to four, provide extended payment plans for customers unable to repay a payday loan after four rollovers, comply with applicable state laws and regulations in connection with internet lending, and abide by the rules of the National Automated Clearing House Association.
I am not claiming that all companies in the alternative financial services space are complying with all laws and regulations and are following best practices. Nor do I dispute that care must be taken to protect consumers of alternative financial services from those who seek to take unfair advantage of them. As with any business, there are good operators in this space and some not so good. FiSCA’s model code requires that members participate in self-policing the industry and report to FiSCA possible violations of best practices. And members are required to track and respond promptly to customer complaints.
Regulators and law enforcement agencies need to be aggressive with companies that are ethically challenged and are not interested in observing the law. I believe the people in this audience would applaud those efforts as long as they are targeted at specific firms and specific violations of law or regulation.
Where the regulators and law enforcement agencies lose me is when they cast a net so wide that it doesn’t distinguish good operators from the not so good. Operation Choke Point run by the Department of Justice, apparently in coordination with the FTC and some bank regulators, is the best example of casting a net so indiscriminately that one can only conclude that it is intended to drive all providers of alternative financial services out of business by denying them access to the banking system and harassing them with regulatory enforcement actions. This type of action drives banks to “de-risk” (i.e., “dump”) alternative financial service providers to avoid unwarranted scrutiny and greatly increased costs for risk controls.
Operation Chokepoint represents a serious abuse of government power, and it will cause significant harm to the economy generally and to tens of million working class Americans currently relying on alternative financial services. It is my fervent hope that Congress will act to curtail this abusive program immediately after the elections in November.
Some – notably Senator Elizabeth Warren – argue that the government ought to address the needs of low and moderate income Americans by creating a U.S. Postal Service Bank to make short-term loans, cash checks, and offer other alternative financial products and services.
While I welcome this debate in Congress, setting up a government bank to offer alternative financial services is highly unlikely to work in my view, particularly if the bank’s hands are tied by political demands that it offer short-term loans and other products on uneconomic terms. Our experience with extensive government involvement in housing and student loans should give us reason to pause before authorizing the postal service to offer a menu of financial services for which it has limited expertise. Finally, when we view the performance record of nationalized banking systems in various countries around the world, we find bloated bureaucracies and balance sheets loaded with unsound loans to politically favored companies and individuals.
I believe competition is the only practical way to ensure that markets are efficient and offer the best services on the best terms. Instead of trying to remove lawful competitors from the marketplace for services to lower income households, we should encourage more competitors to enter this space. Regrettably, current public policy is headed in the opposite direction.
Until about a year ago, four relatively large banks (Regions, Fifth Third, US Bancorp, and Wells Fargo) offered a deposit advance product that was competitive in the short-term loan space. Each bank dropped the product, reportedly in response to regulatory pressures. There must have been some rationale behind the regulators’ decision to force the banks out of this product, but it is not obvious.
The deposit advance product was popular with customers, particularly those with lower incomes, and profitable to the banks which are regulated and highly regarded. With the banking system not reaching effectively the lower quartile of the population in the U.S. – and only roughly half of the black, Hispanic, and American Indian/Alaskan populations – I would think that regulators would be working with banks to find ways to improve and expand their offerings to moderate and lower income customers, not forcing banks out of products aimed at this segment. If I were CEO of a regional bank and if I could get a green light from the regulators, I would seriously consider purchasing a firm offering alternative financial services and running it as a free-standing business serving low-to-moderate income customers and educating and nurturing them to become customers of the bank in due course.
Our government has devoted enormous amounts of time, energy and money during the past six years heaping vast amounts of new regulatory burdens on banks and imposing staggering fines. The direct cost to the banks is measured in hundreds of billions of dollars. The cost to the nation in terms of diminished economic growth and productivity is likely measured in trillions of dollars. We all share in that cost.
The more liability and risk we impose on banks for such things as anti-money laundering violations; not supervising vendors; and mortgage origination, servicing and collection practices, the more risk averse banks become and the less willing they are to serve those individuals and companies most in need of banking services. Cash and the shadow banking system play a larger and larger role in the economy, which results in less transparency in terms of money laundering and greater potential threats to financial stability.
A large and growing percentage of our population and our economy is not being served by the regulated banking system. This is the wrong direction for our banks and our nation. The unintended consequence of our misguided policies is that the very people who most need basic regulated financial services are the ones banks have the most difficulty reaching.
The problems and unintended consequences are not confined to the U.S. Banking systems of countries and regions throughout the world are in danger of being cut off from the global banking system due to their inability to implement anti-money laundering regimes satisfactory to the U.S. In a retreat from prior policy that recognized the value of the transparency created by inclusion, recent public enforcement actions and strong statements by regulators and law enforcement officials have incentivized exclusion. At risk are banking systems in regions that tend to be among the poorest in the world and most in need of robust global banking services. I don’t believe it serves U.S. interests if those economies deteriorate further and their banking transactions go underground.
I want to leave you and the banking industry, as well as the regulators and politicians who I hope read this speech, with three calls to action:
- Operation Choke Point is a serious abuse of government power, is wrong, and needs to be stopped dead in its tracks by Congress. I urge prompt passage of Rep. Luetkemeyer’s bill in the House. I understand the pressure the banks are under from their regulators, but what is happening is disgraceful. I challenge the banks that have left your industry to come back and restore years-long profitable relationships with legal, licensed businesses such as yours.
- Government should be encouraging payday, installment, title loans and other access to small dollar credit, nationally – in banks and nonbanks alike. Let’s open up the ability to offer these products and let the marketplace work, reducing prices and giving consumers more and better options.
- We should encourage, not discourage, banks to get into your business by offering your products and/or merging with your companies. This will increase competition and bring down prices, will allow all firms to participate on a level regulatory playing field, and will bring tens of millions of underserved customers into the banking system.
Thank you for allowing me to share my thoughts today. I hope your conference is a big success and that you will soon be able to focus most of your attention on serving customers without fear of losing your banking relationships.
