Federal regulators have long expected banks to make loans with a high degree of confidence that borrowers will repay them. But some banks supervised by the Federal Deposit Insurance Corp. (FDIC) issue loans, on behalf of payday lenders, that have dangerously high levels of default. These loans, known as “rent-a-bank” loans, have much higher loss rates than other banking system products, including the small loans that banks offer directly to their own customers with low credit ratings.
These bank lease loans are possible because banks are only required to meet the interest rate limits of their home state, not those of the borrower’s state. For example, half a dozen small banks now make loans on behalf of payday lenders at interest rates far higher than those allowed by the borrowers’ home states, with payday lenders only being able to make the loans. ‘because of the charters of the banks. These loans are very similar to the types of credit offered indiscriminately to non-customers that banking regulators – due to their mandate to keep the banking system safe and sound by limiting unsafe practices – have historically shut down.
Asset quality is a key metric in the federal supervisory rubric used to assess a bank’s risk management, which includes an assessment of the likelihood that a bank’s loans will be repaid. Federal banking regulators explicitly stress that small-dollar loans should be made with “a high percentage of customers successfully repaying…” Yet in 2019, the three largest payday loan companies involved in bank lease loans had annualized net losses averaging 50%, unlike other loans issued by banks which, across the banking system, recorded losses ranging from 2% to 9% that year. (The 2019 figures are most relevant due to historically unusual borrowing and repayment patterns in 2020 and 2021 as a result of the government response to COVID-19.) These loss rates resemble payday loan rates not online banking, which are based on the payday lender business model, characterized by high customer acquisition costs, losses, overhead and interest rates, and are approximately 12 times higher than credit card loss rates over the same period and more than five times higher than those of small loans from banks and credit unions—suggesting that lending banks had a relatively low expectation of repayment.
Normally, high loss rates in rent-a-bank lending would trigger regulatory scrutiny because they suggest unsafe lending. However, banks sell most of these loans or receivables to their payday loan partners after origination, so the results of bank lease loans are largely hidden from view from bank examiners. By selling the loans, the banks are essentially moving earnings data off their books — which are scrutinized in standard banking reviews — and into the earnings results of payday lenders, which are not.
There is a better way. Banks should provide access to secure credit by following the example of the growing number of institutions that provide small loans to their customers on fair terms, while controlling losses. In fact, many banks serve borrowers with similar credit profiles as payday borrowers, but have much higher repayment rates; these banks are increasingly leveraging technology, particularly in automating loan underwriting and origination, to outperform non-bank lenders in terms of speed of underwriting, ease of access to loans and certainty of approval, which are the main reasons borrowers have historically turned to payday lenders. This approach leads to affordable loans for bank customers, which helps improve both their financial well-being and their inclusion in the banking system.
It’s time for the FDIC to put an end to high-cost, loss-making rent-a-bank lending, which harms the financial health of customers and undermines safe lending practices in the banking system.
Alex Horowitz is a Principal Officer and Chase Hatchett is a Senior Associate of The Pew Charitable Trusts Consumer Lending Project.