Looking to provide a path forward for lenders considering small-dollar products to offer consumers, federal financial regulators recently issued principles for conducting small-dollar lending.
The principles were released by the Federal Deposit Insurance Corp., the Federal Reserve, the National Credit Union Administration and the Office of the Comptroller of the Currency.
The agencies said they wanted to encourage supervised institutions to offer responsible small-dollar loans to customers for consumer and small-business purposes.
“The agencies recognize the important role that responsibly offered small-dollar loans can play in helping customers meet their ongoing needs for credit due to temporary cash-flow imbalances, unexpected expenses, or income shortfalls, including during periods of economic stress, national emergencies, or disaster recoveries,” the agencies stated. “Well-designed small-dollar lending programs can result in successful repayment outcomes that facilitate a customer’s ability to demonstrate positive credit behavior and transition into additional financial products. The agencies offer these principles due to the evolving conditions and products in the small-dollar loan markets over the last several years.”
They began by stating that the current regulatory framework allows institutions to offer “responsible” small-dollar loans – a fact which was not uniformly in place as recently as three years ago. They stated that institutions are well-suited to meet credit needs, and that the principles cover a variety of small-dollar loan structures – including open-end lines of credit or closed-end loans with short- or long-term repayments.
“Responsible small-dollar loan programs generally reflect 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, pricing, and safeguards that minimize adverse customer outcomes, including cycles of debt due to rollovers or reborrowing; and
- Repayment outcomes and program structures that enhance a borrower’s financial capabilities.”
The regulators reminded institutions that if they are considering new or expanded programs, they should consider sound risk management principles alongside the guidance issued.
“Well-managed programs will generally align with the financial institution’s overall business plans and strategies,” they stated. “Programs could include effectively managed deployment of innovative technology or processes for customers who may not meet a financial institution’s traditional underwriting standards.”
The agencies said those programs could be conducted in-house or through third-party vendors, but that any program should ensure fair access to financial services, fair treatment of customers, and compliance with fair lending and consumer protection laws.
“The agencies encourage financial institutions to refer to the core lending principles below when implementing reasonable policies and risk management practices for responsible small-dollar lending activities,” they stated. “The agencies believe that financial institutions can offer small-dollar loans safely and responsibly.”
The core lending principles the agencies released for institutions that offer small-dollar loan products include:
- Loan products are consistent with safe and sound banking, treat customers fairly and comply with applicable laws and regulations.
- 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 sound risk management practices together support a financial institution’s ability to identify, monitor, manage, and control the risks inherent in its lending activities, including responsible small-dollar lending programs,” they stated. “Effective management of such risks may include new product development protocols that address, among other issues, the clear disclosures of terms, the risk profile of customers using the products, the use of new technologies, the use of alternative underwriting information, or the use of third-party arrangements.”
Finally, the agencies discussed the loan policies and practices and controls needed for small-dollar lending programs.
They said those generally would address:
- Loan structures: Loan amounts and repayment terms that align with eligibility and underwriting criteria and that promote fair treatment and credit access of applicants, and product structures, including shorter-term single payment structures, that support borrower affordability and successful repayment of principal and interest/fees in a reasonable time frame rather than reborrowing, rollovers, or immediate collectability in the event of default.
- Loan pricing: Loan pricing that complies with applicable state and federal laws and reflects overall returns reasonably related to the financial institution’s product risks and costs. Any products offered through effectively managed third-party relationships would also reflect the core lending principles, including returns reasonably related to the financial institution’s risks and costs.
- Loan underwriting: Analysis that uses internal and/or external data sources, such as deposit account activity, to assess a customer’s creditworthiness and to effectively manage credit risk. Such analysis may facilitate sound underwriting for credit offered to non-mainstream customers or customers temporarily impacted by natural disasters, national emergencies, or economic downturns. Underwriting also can use effectively managed new processes, technologies, and automation to lower the cost of providing responsible small-dollar loans.
- Loan marketing and disclosures: Marketing and customer disclosures that comply with consumer protection laws and regulations and provide information in a clear, conspicuous, accurate, and customer-friendly manner.
- Loan servicing and safeguards: Processes that assist customers in achieving successful repayment while avoiding continuous cycles of debt and significant credit costs because of rollovers or reborrowing. For customers who experience distress or unexpected circumstances affecting their ability to repay small-dollar loans, such processes may include timely and reasonable workout strategies. Such processes also could include restructuring single payment loans or open-end lines of credit into installment loan structures in appropriate circumstances.