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Financial Institution Letters
Affordable Small-Dollar Loan Guidelines
The purpose of these guidelines is to encourage financial institutions to offer small-dollar credit products that are affordable, yet safe and sound, and consistent with all applicable federal and state laws. Because such products are in great demand, the FDIC would like to raise awareness that some institutions have found ways to offer them in a cost-effective, safe and sound manner.
These guidelines explore several aspects of product development, including affordability and underwriting. They also discuss tools, such as financial education and savings, that may address long-term financial issues that concern borrowers. Moreover, the guidelines address the FDIC's examination treatment of affordable small-dollar lending programs. Safe and sound small-dollar lending programs that comply with consumer protection laws will not be criticized by FDIC examiners. Importantly, the FDIC recognizes that the Community Reinvestment Act (CRA) provides a valuable incentive to offer affordable small-dollar loans. Institutions that provide such products consistent with these guidelines will receive favorable CRA consideration as outlined in the CRA section below.
Demand for Affordable, Reasonably Priced Small-Dollar Loans – An Opportunity for Financial institutions
The widespread repeat use of fee-based overdraft programs and the growth of payday lending1 confirm that loans in small-dollar amounts are in strong demand. Consumers who make use of these products are institution customers because both products typically require consumers to have a checking account. Providing more reasonably priced small-dollar loans to existing customers can help institutions retain these customers and avoid the reputation risk associated with high-cost products.
In addition, affordable short-term loan programs, particularly those offered to LMI individuals and in LMI areas, may be used as a marketing vehicle to tap into the underbanked market. This strategy has been pursued by some financial institutions as one important part of a profitable, long-term, multiple-account relationship for these individuals that may also include financial education, workplace financial services, individual development savings accounts, foreign remittances, and other services.
Applicability of Subprime Lending Guidance to Affordable Small-Dollar Loan Programs
The FDIC recognizes that an affordable small-dollar loan program may need to serve customers who have poor or limited credit histories, or who would otherwise be characterized as subprime borrowers. However, the interagency Expanded Guidance for Subprime Lending Programs2 limits the definition of subprime lending as a program with an aggregate credit exposure greater than or equal to 25 percent of Tier 1 capital. Accordingly, affordable small-dollar loan programs that fall under the 25 percent of Tier 1 capital threshold would not be expected to provide the additional capital. Given the nature of affordable small-dollar loan programs, the FDIC expects that such programs typically would fall under this threshold and would not warrant unusual examination scrutiny.
Features of Responsible, Affordable Small-Dollar Credit Programs
Some small-dollar loan programs are designed for a broad base of customers. Others are targeted to certain markets, such as military customers, employers, LMI customers, the underbanked, or customers with a limited or non-existent credit history. Still other programs are developed to address the regulatory recommendation articulated in prior guidance that financial institutions monitor customer use of products such as fee-based overdraft programs and, when usage becomes excessive, offer or refer a customer to a more suitable product.3 The goal of all these programs is to enable insured institutions to better serve an underserved and potentially profitable market while helping consumers avoid, or transition away from, reliance on high-cost debt.4
When used comprehensively, the features described below can help institutions meet the goal of safe and sound small-dollar credit programs, which is to provide customers with credit that is both reasonably priced and profitable. Some standard products, such as lines of credit and closed-end installment loans, can be offered with features that make them particularly responsive to borrower needs. For example, lines of credit may be more responsive to individuals who need immediate access to credit when emergencies arise and prefer conducting such transactions privately. Where open-end credit is offered, products should be structured to require minimum payments of interest and principal that provide for the reduction of the outstanding loan over a reasonable timeframe. Where closed-end credit is offered, it should be structured to be repaid in affordable installments within a specified period. New products should be appropriate for the group of customers targeted, as well as compliant with all applicable laws.5 Most importantly, however, credit should be provided in a manner that offers borrowers a meaningful opportunity to repay based on their circumstances.
Over time, borrowers should be able to improve their credit histories and graduate to other more significant asset-building loans, such as home mortgage loans and small business loans. We encourage institutions to make borrowers aware that they offer such products.
Community Reinvestment Act Consideration for Small-Dollar Loan Programs
Under interagency guidance, examiners may favorably consider small-dollar loan programs when evaluating the lending performance of small, intermediate-small, and large institutions. While credit needs vary from community to community and no one activity results in an examination rating, the Federal banking agencies have recognized that some activities, such as making affordable small-dollar loans, are likely to be particularly responsive in helping to meet the credit needs of many communities.8 To be considered, small dollar loan programs should be made generally available and result in loans to individuals across different income levels, including low- and moderate-income individuals.9 A small-dollar loan program may not be large quantitatively compared to some other lending programs offered by an institution. Nevertheless, a small-dollar loan program may be uniquely responsive to a compelling need for an alternative to high cost credit and, therefore, have significant impact qualitatively. It is this qualitative consideration of a small loan program that may strengthen an institution's lending performance to help achieve a Satisfactory rating, or to the extent performance exceeds Satisfactory standards, to help achieve an Outstanding rating.10
The Federal banking agencies have also emphasized that programs that transition borrowers from higher cost loans to lower cost loans are particularly responsive to community needs.11 Consequently, offering lower cost alternatives to such borrowers also will be viewed as responsive in the CRA examination.12
Some small-dollar loan programs may also qualify for favorable consideration under the community development service criteria.13 These include small dollar programs that, for example, may include: 1) a low-cost checking or savings account; 2) financial education that includes a component on how to avoid lending that may be abusive or unsuitable; or 3) free government and payroll check cashing that increases access to financial services for lower income individuals.
Affordable small-dollar loans are in demand. Many consumers turn to high-cost non-bank lenders because they are accessible and can quickly provide these loans. Yet, the inability to repay these short-term, high-cost credit products often leads to costly renewals and exacerbates a customer's difficulties in meeting cash flow needs. Financial institutions can provide the same service with more appropriate loan terms and at a lower cost, and some institutions have found creative ways to do so. In addition, affordable, small-dollar loan products coupled with a savings component can lead to profitable, long-term customer relationships. Affordable small loan programs also receive favorable consideration during CRA examinations. The FDIC encourages institutions to consider opportunities for offering innovative, reasonably priced products that meet this need.
1 Payday loans are small dollar, short-term loans, for which a borrower has given a check postdated to the borrower's next payday, when the full balance of the loan is due.
2 See Subprime Lending: Expanded Guidance for Subprime Lending Programs, FIL-9-2001 (January 31, 2001), http://www.fdic.gov/news/news/press/2001/pr0901a.html.
3 The federal financial institution regulatory agencies have recommended that when overdraft protection is used excessively, customers should be informed of other credit products that may be better suited to their needs. See Joint Guidance on Overdraft Protection Programs, FIL-11-2005 (February 18, 2005), http://www.fdic.gov/news/news/financial/2005/fil1105.html#body.
4 During the December 6, 2006 FDIC Conference, "Affordable, Responsible Loans for the Military: Programs and Prototypes," attendees developed a template for an affordable, small-dollar loan program. Conference participants agreed that the range of options it sets forth would be useful in developing a responsible small-dollar loan program suitable for both an institution and its military customers. See http://www.fdic.gov/news/conferences/militaryloans/Military_Small_Dollar_Loan_Template.pdf - PDF (PDF Help)
5 Products offered to covered military service members and their dependents must comply with the limitations found in the Talent-Nelson Amendment, enacted as section 670 of the John Warner National Defense Authorization Act for Fiscal Year 2007. (Pub. L. No. 109-364, 120 Stat. 2266-2269.) The Talent-Nelson Amendment establishes a number of limitations on extensions of credit to covered service members and their dependents, including restrictions on interest, types of security, prepayment penalties and other terms and conditions. The Talent-Nelson Amendment becomes effective on October 1, 2007. The Department of Defense is to promulgate regulations implementing the Talent-Nelson Amendment by that date. These regulations are expected to further define the type of credit to which these restrictions apply.
6 We encourage institutions to utilize a reasonable time frame for the repayment of closed-end credit, e.g., at least 90 days. This should enable borrowers to repay the debt without incurring the cost of multiple renewals.
7 Pursuant to Federal Reserve Board Regulation E, which implements the Electronic Fund Transfer Act, 15 U.S.C. 1693 et seq., a financial institution is permitted to condition an extension of credit to a consumer on the consumer's repayment by preauthorized electronic fund transfers [i.e., by electronic means on a preauthorized, recurring basis], if the credit has been extended under an overdraft credit plan or to maintain a specified minimum balance in the consumer's account. See 12 C.F.R. § 205.10(e). In addition, the Official Staff Commentary to Regulation E makes clear that a creditor "may offer a program with a reduced annual percentage rate or other cost-related incentive for an automatic repayment feature, provided the program with the automatic payment feature is not the only loan program offered by the creditor for the type of credit involved." See Paragraph 10(e) (1)-Credit to Supplement I of Regulation E.
9 To help limit costs to financial institutions, FDIC examiners will consider information provided on such small-dollar loan programs even though the institution may not have provided other information on consumer loans under data collection requirements. See 12 C.F.R. §345.42.
10 See Interagency Q&As for CRA at §_.28-1 & .28.-2.
11 See Interagency Q&As for CRA at §_.22(a)-1.
13 Id., at §_.12(i) -3.
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