Seeking A More Responsible Small-Dollar Loan (Progress Illinois)

By Adam Doster

July 28, 2010

In one of the more consequential legislative changes this past session, the General Assembly passed a bill almost unanimously that will close a major loophole in the state's 2005 Payday Loan Reform Act. Thanks to the new law, lenders can no longer dish out a "consumer installment loan," (CILA) the structure of which is virtually identical to payday loans, without making the terms of the loan less usurious. This reform ended a decade-long campaign to impose modest regulations on the payday lending industry, which exploded in Illinois during the Bush years and locked thousands of low-income borrowers into a devastating cycle of debt. Last year, the Department of Financial and Professional Regulation estimated that a somewhat similar proposal would have saved borrowers $850 million annually.

While consumer advocates have fought valiantly for these important reforms, the fact remains that the small-dollar loan regulations on the books in Illinois still leave a lot to be desired. The CILA package imposes a cap of 99 percent APR interest on loans under $4,000, which is better than nothing but is still awfully high. (Frankly, that's why the bill garnered support from the state's two major installment loan trade associations.) The 2005 payday loan act prohibits financial institutions from charging more than $15.50 per $100 loaned out every two weeks, which sounds reasonable but actually averages out to around 350 percent APR. Unfortunately, the industry's influence in the statehouse makes it nearly impossible to pass stricter regulations.

At the same time, the demand for small dollar loans is still strong, especially in low-income neighborhoods and communities of color. With wages declining, jobs disappearing, and cost-of-living increasing, a startling number of working families face near-impossible economic decisions every day. On top of that, 51 percent of African Americans and 48 percent of Latinos in Illinois don't have enough financial assets to get them through times of economic stress. (For whites, the figure is just 19 percent.) When an expensive medical bill comes through, a car breaks down, or someone loses his or her job, payday loans are one of the only lifeboats around. "We know the demand isn't going away," says Andrea Kovach, a staff attorney with the Sargent Shriver National Center on Poverty Law. "We just need to raise the supply of safer loans."

After devoting considerable energy toward reigning in the excesses of payday lenders, consumer groups in Illinois are now pivoting, turning their attention to expanding access to responsible small-dollar loans.

A leader in this effort is the Illinois Asset Building Group (IABG), a diverse statewide coalition of community organizations, think tanks, and financial institutions whose goal is to "strengthen communities through increased asset ownership and protection." Kovatch says the organization defines a responsible loan fairly simply: it should have sound underwriting, meaning the lending institution takes into account a borrower's ability to repay the loan when they write the contract; its length should be at least 90 days and should be close-ended, thus preventing costly "rollover" extensions; its maximum interest rate, with fees included, should be 36 percent APR; and there should be a clear, "amortized" payment schedule.

Their job now is to convince local mainstream banks and credit unions (many of whom provide services that don't suit the financial needs of low-income households) that distributing loans with those terms to the "unbanked" can still net a profit. Thankfully, there are already a few local financial institutions charting a path forward.

Three local banks participated in the FDIC's Small-Dollar Loan Pilot Program, the results of which were just released. That included the Lake Forest Bank and Trust, which offers a loan with no fees and an interest rate of just 5 percent above the prime level. The FDIC concluded (PDF) the bank turned a small profit on those loans generally and any losses that occurred for an individual borrower were no higher than standard consumer loans. This data tracks with a 2007 Woodstock Institute study that found short-term loans available from six local credit unions generated profits.

Within the next few weeks, IABG plans to publish a report for banks that lays out in detail how institutions can benefit by distributing these safe loans. Kovatch says the chief value for institutions she's studied is that they can establish long-term relationships with successful borrowers who they would have otherwise overlooked. Reaching out to the unbanked also creates what the FDIC calls "good will in the community" that can draw in additional customers or corporate and non-profit supporters. (We will be sure to review IABG's study when it is released.)

Legislators and other state officials who are critical of high-interest loans also have a role to play in broadening the market for small-dollar alternatives. For starters, they can organize regulators from the FDIC and Federal Reserve, state banking associations, and community organizations to create a small-dollar loan pool. The idea here is that the government and participating financial institutions provide the initial funding for a pool of loans, money that is then disbursed to needy borrowers collaboratively with the administrative assistance of trusted community groups. For wary banks, the existence of a pool diversifies risk while still improving the banks' image in the community.

The General Assembly could also provide short-term credit to low-income families directly as the government does in Britain, which can save taxpayers money in the long run by keeping people off other forms of government assistance. The state treasurer's office could even provide additional deposits to credit unions and banks that offer those reasonable products. (IABG's white paper on the topic is available for download here.)

Subsidizing savings for children is another important tool that can shrink the demand for emergency loans in the future, and it's a proposal that advocates in the state are working hard to promote. In August 2007, former Gov. Rod Blagojevich signed into law legislation creating a task force charged with developing a Children’s Savings Account (CSAs) program in Illinois. These are opened up for a child at birth and are typically locked in until he or she turns 18, when the money can be pulled out to use on things like college tuition, home purchases, or small business overhead costs.

Chaired by Dory Rand of the Woodstock Institute, along with representatives from the governor's and treasurer's office, the group has met four times in the past four months to devise best practices for Illinois' program. (There's a similar bill that's been introduced at the federal level, as well.) After holding three public meetings, the coalition is expected to publish its written recommendations later this year. It's a document that lawmakers should study intently.

There's a broad consensus that more savings and safer loans can play a key role of securing a sustainable economic recovery. With some effort, Illinois could be a leader in that nascent movement. "This is absolutely on the radar of regulators and legislators," says Kovatch. "They just want a bit more information about how it all works."

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