Creation of Safe, Affordable and Feasible Template for Small-Dollar Loans
Small-dollar loan pilot
The Small-dollar Loan Pilot Project was a study to find if it is profitable for banks to offer small-dollar loans to their customers. Small-dollar loans were created as an option to expensive payday loans, or heavy fee-based overdraft programs. This study opened up opportunities for small-dollar loans to be more affordable.
Small-dollar loans have created a way to maintain associations with current costumers and opportunities to attract unbanked new customers.
Goals: The main goal the FDIC had in mind for small-dollar loans was for banks to create long-lasting relationships with their customers using the product of small-dollar loans. Many banks had another goal in mind in addition to the FDIC’s goal. Some banks wanted to become more profitable by producing the product while other banks produced the product to create more goodwill in their community.
Where and how the study started: The FDIC found 28 volunteer banks with total assets from $28 million to nearly $10 billion to use the new product, offering of small-dollar loans. All were found in 450 offices in 27 states. Now, in the pilot study there have been over 34,400 small-dollar loans that represent a balance of $40.2 million.
Template for small-dollar loans: Loans are given with an amount of $2,500 or less, with a term of 90 days or more. The Annual Percentage Rate is 36 percent or less depending on the circumstances of the borrower. There are little to no fees and, underwriting follows with proof of identity, address, income, and credit report to decide the loan amount and the ability to pay. The loan decision will usually take less than 24 hours. There are also additional optional features of mandatory savings and financial education.
Long loan term success: Studies found that having a longer loan term increased the amount of success in small-dollar loans. This allowed the customer to recover from any financial emergency by going through a few pay check cycles before it was time to start paying the loan back. Liberty Bank in New Orleans, Louisiana offered loan terms to 6 months in order to avoid continuously renewed “treadmill” loans. The pilot decided that a minimum loan term of 90 days would prove to be feasible.
Often the bank will require the customer to place a minimum of ten percent of the loan in a savings account that becomes available when the loan is paid off.
Delinquencies: In 2009 the delinquency rates by quarter for small dollar loans were 6.2 in the fourth, 5.7 in the third, 5.2 in the second, and 4.3 in the first.
How to be most successful when producing small-dollar loans: The FDIC is reporting that the participating banks have found much success through small-dollar loans. But the most success came from long term support from the bank’s board, and the senior management. It is critically important to have strong support coming from senior management.
The small-dollar loan pilot has proven to be a great addition to bank’s loan portfolio, the FDIC hopes that it will spread to banks outside the pilot.
Profitability may depend on location: The FDIC has found the most successful programs are in banks located in communities with a high population of low- and moderate-income, military, or immigrant households. Banks in rural areas that did not have many other financial service providers also saw feasibility because of the low amount of competition.
Improving performance: Automatic repayments are a way to improve performance for all products not just the small-dollar loans.