NextThought Monday: Why I’m optimistic about small-dollar credit in the U.S.
Paging through my notes on the train ride home after a recent conference on small-dollar credit, I might have felt discouraged.
Several speakers at the conference, organized by the Philadelphia Federal Reserve’s Payment Cards Center, pointed out that the dangers of payday loans and similar products are the same today as nearly 100 years ago: they are extremely expensive, often with triple-digit interest rates, and structured in a way that almost guarantees they will get rolled over again and again, trapping borrowers in a cycle of debt.
So, if not much has changed in 100 years, then why wasn’t I discouraged? Why, in fact, did I leave feeling even more optimistic about the future of the small-dollar credit marketplace than ever?
Because while the risks of payday loans have remained the same for 100 years, so much else has changed. We know more about small-dollar credit borrowers than ever before, thanks to a growing body of research by institutions like the Pew Charitable Trusts, the Center for Responsible Lending, the Urban Institute and Innovations for Poverty Action, to name just a few. CFSI has done our own in-depth research, including a quantitative survey of 1,100 small-dollar credit consumers and a qualitative deep-dive with 31 borrowers of three different types of loans, the results of which will be published in a series of reports over the next several months. We’ve learned a lot about what small-dollar credit consumers need and want, and now we’re able to use those insights to design better products.
What might a better small-dollar credit product look like? Perhaps most importantly, the lender would expect that the borrower will repay it, on time and without rollovers. This means that lenders must invest in the capacity to do responsible underwriting, rather than accepting a high default rate as a necessary cost of doing business. Doing so will enable lenders to distinguish higher-risk borrowers from lower-risk borrowers, and price their loans accordingly. Credit will become much more affordable for the many consumers who use it responsibly.
(Of course, there will be some consumers accessing credit in today’s zero-underwriting world who will no longer qualify; CFSI’s research shows that roughly 30 percent of all small-dollar credit customers borrow to fill a persistent gap between their income and expenses. For these borrowers, non-credit solutions like budgeting guidance, better jobs, income support or savings tools might be more appropriate.)
(Left: Beth Brockland)
CFSI will soon have more to say about what makes a better small-dollar loan. While responsible underwriting is critical, there are many other factors that, when taken together, result in a high quality product. We are currently developing guidelines and best practices for small-dollar credit as part of our Compass Principles program, in consultation with thought leaders from industry, nonprofits and academia. Stay tuned.
But, to get back to my topic for this blog: why did the Philly Fed’s small-dollar credit conference leave me feeling so bullish? Two more reasons: new data and new models.
One of the speakers, Jeff Feinstein of LexisNexis Risk Solutions, gave attendees a peek at the wealth of data his firm has amassed that shed light on the creditworthiness of the 70 million consumers with thin or no credit files. Other firms, including some innovative start-up lenders, are also using big data to better understand – and ultimately better underwrite – small-dollar credit consumers. This data didn’t exist 100 years ago, or even 20 or 10 years ago. Lenders who can safely leverage these new data sources, which will only get better and more predictive over time, will emerge as the market leaders in the years to come.
Another speaker, Brad Hanson of Meta Payment Systems, spoke about a soon-to-be launched product: a secured credit card tied to the tax season. Meta’s customers will be able to use part of their tax refund to secure the card, which in turn, will lower Meta’s risk and allow them to serve more borrowers. What’s exciting is that Meta is not alone; more and more providers, from traditional banks to Silicon Valley start-ups, are experimenting with new approaches to delivering small-dollar loans.
We need a variety of solutions to meet the diverse needs of the small-dollar credit consumer. This isn’t a one-size-fits-all marketplace. With more research, better data and new models, we are poised to see more change in the next 10 years than we’ve seen in the last 100. I think that’s cause for optimism.
Beth Brockland is Director, Compass Principles at the Center for Financial Services Innovation, a content partner on NextBillion Financial Innovation.