On May 20, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency (collectively, the “agencies”) issued interagency principles (the “Lending Principles”) to encourage supervised banks, savings associations, and credit unions (collectively, “depository institutions”) to offer responsible small-dollar loans to customers for both consumer and small business purposes. In doing so, the agencies stated that they recognize that a well-designed small-dollar lending program can both help customers meet their ongoing needs, and, by generating successful repayment outcomes, facilitate customers’ ability to demonstrate positive credit behavior and transition into additional financial products. The Lending Principles emphasize that depository institutions are “well-suited to meet these credit needs and some already offer these products, consistent with safe and sound principles and subject to applicable laws and regulations.”
The Lending Principles cover a broad range of small-dollar credit products, including open-end lines of credit with applicable minimum payments and closed-end loans with shorter-term single payment or longer-term installment payment structures. Importantly, the Lending Principles also note that depository institutions may, but are not required to, discuss plans for small-dollar loan products with the relevant agency before implementation, particularly where they might involve “substantial deviations” from existing business plans.
Characteristics of Responsible Small-Dollar Loan Programs
The Lending Principles identify the following three characteristics of “[r]esponsible” small-dollar loan programs, all of which focus on repayment terms and outcomes:
- A high percentage of customers successfully repaying their small-dollar loans in accordance with original loan terms, which the agencies note is “a key indicator of affordability, eligibility, and appropriate underwriting”;
- Repayment terms and features that “minimize adverse customer outcomes, including cycles of debt due to rollovers or reborrowing”; and
- Repayment outcomes and program structures that enhance a borrower’s financial capabilities.
The Lending Principles contemplate a range of different approaches to developing a responsible small-dollar lending program. For example, the agencies note that such products may involve “effectively managed deployment of innovative technology or processes for customers who may not meet a financial institution’s traditional underwriting standards.” The agencies also note that such programs may be implemented either by the depository institution directly or through third-party relationships—though the Lending Principles emphasize at multiple points the importance of managing and overseeing the risks posed by such relationships.
The Core Lending Principles
The agencies identify the following “core” lending principles for depository institutions that offer small-dollar loan products:
- Loan products should be consistent with safe and sound banking, treat customers fairly, and comply with applicable laws and regulations;
- Depository institutions should effectively manage the credit, operational, compliance, and other risks associated with the products they offer; and
- Loan products should be underwritten based on prudent policies and practices governing the amounts borrowed, frequency of borrowing, and repayment requirements.
The agencies emphasize the importance of policies and risk management practices that permit a depository institution to identify, monitor, manage, and control the risks posed by responsible small-dollar lending programs. The agencies specifically highlight the need for product development protocols that address a range of identified issues, including the clear disclosure of terms, the risk profile of customers using the products, the use of new technologies, the use of alternative underwriting information, and the use of third-party arrangements.
The Lending Principles also identify five specific areas that loan policies and risk management practices and controls for small-dollar lending should address:
- Loan structures. The agencies emphasize that loan amounts and repayment terms should both align with eligibility and underwriting criteria and support borrower affordability and successful repayment of principal and interest/fees, rather than “reborrowing, rollovers, or immediate collectability in the event of default.” In this regard, the agencies acknowledge that such product structures may include single payment structures that are “shorter-term” (which they do not define).
- Loan pricing. The agencies note that loan pricing should not only comply with applicable laws, but also reflect ”overall returns reasonably related to the financial institution’s product risks and costs.” The Lending Principles do not include any specific limits or caps on interest rates, fees, or other pricing elements.
- Loan underwriting. The agencies note that depository institutions may underwrite small-dollar loans using internal and/or external data sources, and specifically acknowledge deposit account activity—the basis of so-called “cash flow” underwriting—as such a source.
- Loan marketing and disclosures. The agencies stress that marketing and customer disclosures should not only comply with applicable consumer protection laws, but also provide information in a “clear, conspicuous, accurate, and customer-friendly manner.”On this point, they also highlight several specific consumer protection laws, including the Equal Credit Opportunity Act, the Truth in Lending Act, Section 5 of the Federal Trade Commission Act, and the Dodd-Frank Wall Street Reform and Consumer Protection Act’s prohibition of unfair, deceptive, or abusive acts and practices.
- Loan servicing and safeguards. The agencies draw particular attention to servicing and workout processes, noting that they should avoid “continuous cycles of debt and significant credit costs due to rollover or reborrowing.” They note that, for customers who are experiencing financial difficulty, such processes may include “timely and reasonable workout strategies,” as well as restructuring single payment loans or open-end lines of credit into installment loan structures “in appropriate circumstances.”
Other Observations
Prior Efforts Regarding Small-Dollar Loan Products. The issuance of the Lending Principles follows upon prior statements by federal banking agency leaders, including those made by FDIC Chairman Jelena McWilliams and OCC Comptroller Joseph Otting, regarding the importance of encouraging banks to offer small-dollar loan products to customers in need. The Lending Principles also are similar to, and build upon, core lending principles articulated by the OCC several years ago in OCC Bulletin 2018-14 (which is now rescinded and superseded by the Lending Principles)—though the Lending Principles provide more detail than, and differ in meaningful ways from, the prior OCC guidance.
The Role of the CFPB. The issuance of the Lending Principles should provide much-needed clarity regarding how the agencies are likely to view small-dollar lending by depository institutions as a supervisory matter. At least as important are the views of the Consumer Financial Protection Bureau (the “CFPB”), which has sole rulemaking authority over the principal consumer protection laws applicable to small-dollar lending, as well as supervisory authority for purposes of such laws for depository institutions with assets over $10 billion. The CFPB is expected to issue a final rule on small-dollar lending in the near future.
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Covington & Burling LLP’s Financial Services attorneys have deep experience guiding U.S. and non-U.S. financial institutions through the most challenging circumstances, including the 2008–09 financial crisis. Our team, which includes former senior federal regulators, stands ready to advise financial institutions as they navigate the impact of COVID-19 on the economy and the financial markets.
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