Thinking small, as in short-term low-dollar personal loans, and businesses seeking funds to grow, could help financial institutions cultivate assets with the right bank collection software helping to monitor the risks.
Underserved individuals and small businesses present a challenge for community financial institutions. In recent years, nonbanks and alternative lenders have challenged conventional financial institutions, in these markets.
Today’s consumer and commercial credit market shows the need for underwriting and collection models sufficiently flexible beyond traditional credit so lenders can efficiently evaluate risk and confidently recover debt.
Financial institutions lend money for significant, but necessary items like vehicles, education and home repairs.
In the past and with the correct systems in place a bank or credit union would target only those meeting pre-defined measures to offer these types of loans and avoid applicants with poor credit histories.
However, the U.S. lending market has seen new competition including alternative channels, a growing resource of digitally based lending platforms that meet different borrowing needs.
Fintech startups, technology firms, and even commercial and investment banks have all infiltrated what was once the primary domain of community financial institutions.
Access to reasonably priced, short-term funds is more important than ever. Millions of Americans live paycheck to paycheck, leaving consumers with less cushion for emergencies, stressed credit scores, and less credit choices. According to the Federal Reserve, nearly half of all American adults say they cannot cover an unexpected expense of $400.
While financial institutions provide a variety of small dollar credit options, including credit cards, short-term installment loans, and overdraft services, prior to 2013, some offered a deposit advance product for emergency credit.
Unfortunately, 2013 FDIC and OCC guidance removed the ability of many severely regulated financial institutions to offer a viable alternative to compete with nonbank lenders.
An ABA white paper suggested the demand for small dollar credit is sizeable and real; and needs unmet by financial institutions will drive customers toward “informal” sources.
Few financial products draw as much criticism as payday loans do, often seen as predatory, primarily because of high interest rates and because lenders often subject borrowers to collection actions and lawsuits.
Small-dollar bank loans from community financial institutions generally require a pre-existing customer relationship, limitation on loan amounts, an ability to repay, a checking account in good standing and regularly scheduled deposits.
In comparison, payday loans from nonbanks require no customer relationship or limits on loan amounts or quantity; little to no ability to repay analysis; and few if any disclosures explaining loan terms and conditions.
Nevertheless, payday lenders moved in to capitalize on a need. According to the CFPB, payday loan companies – which are not legal debt collection agencies but are permitted to act to collect debts consumers owe – took in roughly $3.6 billion in fee revenue in 2015. The CFPB also estimated that there are 15,766 U.S. payday loan stores.
A new CFPB rule issued in October 2017 aims to stop debt traps by establishing tougher ability-to-repay protections.
Under the new rule, lenders must conduct a “full-payment test” to determine upfront borrowers’ ability to repay loans without re-borrowing. For some short-term loans, lenders can bypass the full-payment test if they offer a principal-payoff option that allows borrowers to satisfy the debt incrementally.
The rule allows less risky loan options, including certain loans typically offered by community financial institutions, to forgo the full-payment test. The new rule also includes a “debit attempt cutoff” for any short-term loan, balloon-payment loan, or longer-term loan with a yearly percentage rate higher than 36% that includes access the borrower’s checking or prepaid account.
Shortly after CFPB guidance’s release, the OCC rescinded its guidance on small-dollar loans. With this step, and the CFPB’s action, some financial institution see an opportunity to help the underserved/underbanked market.
OCC Acting Comptroller Keith Norieka noted the Guidance not only hurt the very consumers it intended to help but its continuation would subject banks and federal savings associations to potentially inconsistent regulatory direction and undue burden.
Even with the OCC rule’s rescission regulated financial institutions are still accountable for compliance with all prudential and consumer laws and regulations.
Small business lending faces similar hurdles.
After the Great Recession, most community banks had their hands tied when it came to providing loans to small businesses-providing a window for larger banks and alternative lenders.
To capture their fair share of the profit pool in this $1.54 trillion market, according to Forbes, traditional banks might need redefinition of business models through a more personalized approach and understanding of their target customers and better help in the debt gathering process.
Small business lending remains a core community bank product — with 98% of banks with less than $10 billion in assets offering small business loans, according to the ABA.
Still, a survey released in October 2017 by the Federal Reserve and the Conference of State Bank Supervisors found small business lending at community banks fell by 2.2% to $269 billion in 2016 and larger banks (larger than $10 billion in assets) edged their smaller peers in total origination volume, growing by 5.1% from 2015 to 2016, to $284 billion.
Small business loans also declined as percentage of community banks’ portfolios, dipping from 16.6% to 15.9%.
A web-based survey from Boston-based Mercator Advisory Group revealed three in four small businesses delayed routine purchases at least once or twice a year because of cash-flow management issues.
However, it’s not always easy for small businesses to obtain the credit they need, when they need it, due to traditional banks’ often restrictive lending policies. Consequently, small businesses seek credit wherever they can get it, seeking credit lines and loans from financial institutions, nonbanks, and alternative lenders.
For example, Amazon Lending offers short-term business loans ranging from $1,000 to $750,000 for up to 12 months to micro, small and medium businesses selling on Amazon.
Amazon made $1-billion in small-business loans to more than 20,000 merchants in the United States, Japan and the U.K. during the 12 months prior to June 2017. Since Amazon Lending launched in 2011, it surpassed $3 billion in loans to small businesses.
The latest Biz2Credit Small Business Lending Index revealed business loan approval rates at banks continue to climb heading into the fourth quarter of 2017.
This is a good sign because small business loans drive adoption of other products.
According to the ABA Banking Journal nearly 95% of community banks always or usually provided deposit services to small business borrowers, while 38% provided cash management.
Powerful collection software provides banks and credit unions with solid loan collection data reporting. This can better measure their risk tolerance while increasing loan effectiveness and the ability to compete without compromising credit quality and to recover debt.
Robust reporting also helps sort through the loan risk muddle and allows financial institutions to retain some prudent underwriting and risk management principles.
Banks and credit unions armed with the best debt retrieval capabilities can leverage specific scores (contact-ability, collectability, overall recovery) during the loan servicing life, and assign the best channel appropriate bank collection work flows that yield the best possible results to the financial institution.
Proven best-of-breed collections systems automated work flows ensure key steps are completed, documented, boosting compliance while containing collection costs. Providing a 360-degree borrower view, of all accounts, give key information to collection next step decisioning.
A flexible system also permits financial institutions to effectively manage the risks associated with the products they offer, including credit, operational, compliance, and reputation.