November 28, 2018
Joseph Otting, the new head of the little-known but very powerful Office of the Comptroller of the Currency (OCC) is an independent financial regulator within the Treasury Department. Recently, he expressed his desire to allow banks back into the micro/payday lending space of which regulators had forced them out of in 2013. And some, including US Bank, have followed his lead.
For a number of reasons, including the fact that 63% of Americans don’t have savings to cover a $500 emergency, this is the right move. Want to lower interest rates on a product? Want to provide access to more people? You do it by creating a competitive environment and wrapping it in respectability. That is, don’t create more regulation, but rather allow regulated entities that have a certain brand and consumer sensitivities into the marketplace and let the market forces themselves play out. Suddenly you have more customers benefiting from a market, rather than being taken advantage of by it.
It is understood that there are some that are terrified by the idea of a market, any market managing itself. But let us be reminded of two things:
That’s what a true market is and does.
That the mortgage crisis culminating in the 2008 financial collapse (which precipitated the 2013 action) was not created by under-regulation, but rather over-regulation – mandates creating classes of loan products to serve certain sectors of consumers and mandating the quota placement of mortgage dollars going into high-risk borrowers.
When entities that don’t live by market forces dictate scale for actual markets, the worse-off those markets become and a bevy of unintended consequences ensue.
From my offices in Silicon Valley, I sit at ground-zero of technological change. I’m surrounded by it daily. These people are my friends and my cohort. With the reopening of this market, innovators are right now, as I write, creating solutions to create ease of access, simplicity of service, fully digital experience, and documentation efficiencies that benefit consumers and lower the cost of money. Regulations don’t do that – innovators do that in response to markets. And the big banks getting into this market will also have to respond to these innovators. Market forces are a beautiful thing.
Certainly, there is a role for regulation, but I simply don’t buy into the notion that the purpose of regulation is to save people from themselves. The only role for regulation is to:
Level the playing field in the absence of competition
In the financial markets, create a standard list of rules by which all participants must play
The purpose is not to restrict access to markets (by limiting the players that can participate) as in 2013 and think that will protect consumers. It’s doesn’t, it didn’t, and never will.
In this emerging competitive marketplace, there will be millions of more consumers heading to what will become a more mainstream loan product by virtue of respected, trusted, and brand-sensitive banks providing this type of product.
With annual payday lending in the US at approximately $50mm and growth estimates ranging from 6% – 18% per year, this is not an argument against online or neighborhood micro/payday lenders at all. They are a valuable part of the ecosystem and an integral element in a new more competitive environment. But in this new environment, they won’t be able to rely on sky-high interest rates to make their models work: say ‘yes’ to everyone and charge 350% compounded.
In this competitive environment not only will consumers likely be treated more fairly, but the business principles of each lender must be sound AND the risk of each loan well-understood.
With the OCC opening new access channels for consumers, the problem is going to be how to accurately decision these consumers. Currently, there are 56% of Americans that are thin-file, no-file, and credit challenged. This is not because they are poor, or because they are high risk. It’s simply that current decisioning systems only work for a minority of the population (a global problem as well). This is because current systems are scoring systems based on historical data, i.e., past payments = future behavior. The problem is that you need history to get history; you need credit to get credit. Historical systems have codified not bringing in new customers.
Therefore, a major component to increasing access is going to be being able to better decision these consumers. And with more money in the hands of more people at reasonable rates, this problem only gets direr.
In addition to freed market forces feeding innovation, being able to properly decision them is the key to keeping risk low, fees and rates low, and consumers and lenders alike prospering in this new environment.