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FDIC Pilot Program: Banks Make Low-Cost Small Loans

August 13, 2009

As battles over abusive payday lending continue in Wisconsin and in Congress, and as the National Consumer Law Center reports that some banks have begun making similar ultra-high-cost loans themselves, innovative efforts to provide truly affordable small loans are also moving forward.

Last month, we highlighted the nation’s only statewide program offering alternatives to payday loans – Credit Union Better Choice Loans –  jointly sponsored by the Pennsylvania Treasury Department and the Pennsylvania Credit Union Association.

Today, we want to call attention to the FDIC’s progress report on its “small dollar loan pilot program.”  In 2008, the program’s first year, the 39 participating banks made over 16,000 loans for a total of about $18 million.  About half of the loans were for $1,000 or less.  The average interest rate was about 15%, and the average APR (which includes the impact of fees) was less than 20%.  The loan periods ranged from three to twenty-four months, with the average being about twelve months.  Loans repayments are made in a series of installments rather than in a single payment.  Some of the banks reported that the loans were profitable in the short-run, while most regarded them as an investment in customer relationships and community good will that will  increase future profits.

While most of the participating banks developed new loan products for the FDIC program, Amarillo (Texas) National Bank, which made more than a thousand loans of $1,000 or less in 2008, began its small dollar loan program more than a century ago.  This bank is the subject of one of the four detailed case studies included in the FDIC’s report.

To be sure, the $18 million loaned through this program is barely  a drop in the bucket compared to the volume of high-cost payday lending, which the FDIC estimates at $48 billion in 2006.  But the FDIC’s pilot program offers proof that it is indeed possible for banks offer small loans in a responsible and affordable manner.

(Photo: GreatBeyond)

One Comment
  1. August 15, 2009 11:31 pm

    Thank you for the forum to express previously unmentioned reasons for change! The Truth in Lending Act (TILA) of 1968 was passed when access to calculators with “compounding features” were limited to large computers in air-conditioned back rooms. The authors of TILA, Senator William Proxmire and Representative Leonor K Sullivan, knew the difference in the mathematically-true, compounded [“^”] EFFECTIVE APR (EAPR) and the untrue, simple-interest, NOMINAL APR (NAPR). TILA states that the Nominal APR can be used for comparison. Nowhere does it say it is the true rate … even though the title implies “Truth”. When hearings were being held on the legislation, the then Under Secretary, Joseph Barr, presented several methods of calculating the APR, but he guided the subcommittee to the NAPR. 4 joint (Senate/House) compromise meeting were held before the passage of the bill, but they were entirely in Executive Session and no records were kept. The Barr family did have financial interested companies. The financial industry was opposed to the act. Apparently, Proxmire and Sullivan acquiesced on the method to get something pasted on legislation that was first proposed in 1935. At low periodic interest rates and long periods the NAPR is close to the EAPR.
    An example of the difference that occurs, with high periodic rates and short periods, is a loan described in the February issue of Consumer Reports, where a school principal took-out a $400 loan to be repaid with $120 in interest in 16 days. The NAPR, in accordance with Regulation Z of the TILA, is the rate for a period times the number of periods in a year (120/400)*(365/16) = 684%. The mathematically-true APR is the compounded, EFFECTIVE (a named steeped in history) APR (EAPR), the rate for a period compounded (“^”) for the number of payment periods in a year (((1+(120/400))^(365/16))-1) = 39,650%. On the Nominal APR, TILA states the tolerance of accuracy of this “closed-end’ (a stated due date) loan as 1/8th% (0.125%). In this example the Effective APR is 311,728 of those 1/8th%s from the Nominal APR (39,650%-684%)/0.125% … astronomically wrong. In 1968, when interest rates were low (5%) and periods longer (monthly) the Nominal and Effective APRs were very close. In this case the EAPR is 58 times greater than the NAPR (39,650%/684%).

    Now, you may find the above unbelievable, so please check with a teacher of graduate finance, especially a PhD who does not have any obligations to any financial organization or government entity. Now a $4.95 LeWorld hand-held calculator at Wal-Mart has a compounding function. The Truth in Savings ACT uses the EAPR and calls it the Annual Percentage Yield (APY). To change TILA to the truth, the words “multiplied by” should be changes to “compounded for”.

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