Weakened Protections Are a Wake-Up Call for the Financial Sector

Some 78 percent of U.S. workers live paycheck to paycheck, a fact made painfully apparent during the recent government shutdown. Estimates suggest one in 10 Americans have no credit history, with profound financial implications. Now the Trump administration has rolled back protections for those who turn to risky payday loans for quick cash. Is the financial industry stepping up in the wake of these developments?

According to the Center for Financial Inclusion, the U.S. consistently ranks as one of the most affluent countries in the world, but these statistics obscure the financial health of the population. More than one in 10 Americans—nearly 45 million people—are living below the poverty line.

About 7 percent of American households lack access to a bank account, and about 20 percent are “underbanked” - that is, they have a bank account but they also use services associated with the financially excluded, including payday loans, the Center for Financial Inclusion found.

About 40 percent of Americans report not being able to manage a $400 unexpected expense.

Financial firms offer another way

Some banks like Southern Bancorp are offering alternatives tailored to financially underserved minority and rural communities in so-called “financial deserts,” and a start-up called Petal is offering a credit card to people without credit scores.

In addition, a small but growing group of non-bank lenders are working with U.S. employers to offer small-dollar financing tied to wages at a far lower interest rate than payday loans.

These are among financial sector leaders who recognize that financial inclusion initiatives address a huge underserved population. According to the Chamber of Commerce, businesses have the opportunity to reach up to two billion people by designing financial tools and resources to reach unbanked and under-banked communities. 

The problem with payday loans

Payday loans are loans of typically $500 that require only a valid form of identification, proof of income and a bank account. The balance of the loan, along with the "finance charge" (service fees and interest), is typically due two weeks later, on the individual’s next payday. These loans are risky because they're expensive: The national average annual percentage rate (APR) for a payday loan is almost 400 percent. That's over 20 times the average credit card interest rate, CNBC reports.

Obama-era regulations would have required payday lenders to double-check that borrowers could afford to pay back their loan on time by verifying information like incomes, rent and even student loan payments. The rules were set to go into effect in August 2019. The Trump administration put the brakes on, however, and after a review, found the "ability to pay" requirements would restrict access to credit and proposed abandoning these safeguards.

The weakened protections have a direct impact on almost 10 million millennials who have taken out one of these high-interest, short-term loans in the past two years, according to a survey by CNBC Make It and Morning Consult. Nearly 40 percent of Gen Z have strongly contemplated taking a payday loan, the survey found, in part to cover costs associated with attending college.

Mission-driven banks for the underserved

Southern Bancorp takes a different approach to give people an alternative to payday loans. In the states where it operates, the number of unbanked is much higher than the national average of 7 percent, according to Euromoney; in Mississippi, for example, it is 12.6% while the underbanked are 25.5%.

As a certified Community Development Finance Institution (CDFI), Southern Bancorp is mission-driven rather than profit-maximizing. To obtain certification as a CDFI, banks are required to provide financial services primarily in low-income communities and to people who lack access to financing. Nationwide, there are more than 800 CDFIs.

Larger banks are also getting in on the action. Citi and Mastercard partnered with Grameen America, a leading nonprofit microfinance organization, to offer financial technology solutions designed to promote digital financial access and inclusion for more than 86,000 low-income minority women entrepreneurs across the U.S.

Tying small-dollar loans to wages

Non-bank lenders partner with U.S. employers to offer small-dollar financing tied to wages, as Bloomberg reports. United Way offers the platform Salary Finance, and Walmart partners with PayActiv, a San Jose, California-based fintech, to offer pay advances to its 1.4 million employees. Uber drivers can digitally cash out on their hours worked through Palo Alto, California-based Earnin.

Linking a loan to an employee’s salary “allows someone who would otherwise be paying 400 percent to get it at 10 to 15 percent,” Todd Baker, a senior law and public policy fellow at Columbia University’s Richman Center, told Bloomberg Law.

A new option for “credit invisibles”

Low-income consumers, especially those that are unbanked, often struggle to get approved,  even for a low-limit credit card. An estimated 65 million people have insufficient credit history to quality for a traditional credit card.

Jason Gross, founder of Petal, formed the company to connect people with little to no credit history with a line of credit of up to $10,000, according to Fast Company. Petal looks at a person’s whole financial track record to determine creditworthiness, factors such as regular payments like rent, checking account cash flow, or history with prepaid debit cards or secure credit cards.

A study from the U.S. Federal Reserve found that only 42 percent of people earning less than $25,000 per year have a credit card. Gross told Fast Company that his aim was to extend credit to people who have previously been locked out of the system, like immigrants.

The Petal credit card has no annual, over-limit, late-payment, or international fees attached. While it is not a bank, Petal partners with WebBank, the online financial services platform that also powers PayPal and LendingClub. The company also provides data into the three major credit bureaus–Equifax, TransUnion, and Experian–so people can begin to build a traditional credit score through Petal.

Image credit: Mike Mozart/Flickr