Can credit unions be “alternative financial services providers?”

Payday loans are marketed as a quick-fix solution to financial emergencies. However, they carry fees that amount to triple-digit interest rates and often unaffordable payments, leading to a spiral of debt for the most financially vulnerable consumers in lower-income urban and rural communities.

According to the Center for Responsible Lending, payday loans cost Americans over $4.1 billion in fees annually. In Michigan, that number is approximately $100 million through over 550 stores, and online through large national businesses like Advance America and Check N’ Go.

About 5 percent of U.S. adults — or 13 million people — do not have a checking, savings or money market account (often referred to as the “unbanked”). Half of the unbanked use some form of alternative financial service, such as a check cashing service, money order, pawn shop loan, auto title loan, paycheck advance or payday loan.

In addition, 18 percent of adults are “underbanked” — they have a bank account but also use an alternative financial service (AFS) product. The remaining three-quarters of adults are fully banked, with a bank account and do not use alternative financial products.

The unbanked and underbanked are more likely to be low income, less educated, or in a racial or ethnic minority group. Just 1 percent of those with incomes over $40,000 are unbanked, versus one in eight with incomes under that threshold. Similarly, 11 percent of blacks and Hispanics are unbanked, versus 3 percent of whites.

So, with this data in mind, for credit unions who are committed to their social mission of serving the underbanked the question is, “How can credit unions do more to meet the unique needs of the unbanked and underbanked?” Stated differently, “Can credit unions become true alternative financial service providers but in a more consumer-friendly fashion?”

Many credit union leaders would say that they think they serve the underbanked really well. However, there are many forces that limit a credit union’s ability and desire to serve the underbanked.

The truest definition of “underbanked” should be lower-income or credit-challenged consumers, whether in urban or rural areas, who are using at least one AFS as noted above. By far, the most prevalent alternative financial service is payday loans, and these loans are about to grow dramatically as large banks seem poised to enter this business. Large banks’ track records suggest that they will not provide a consumer-friendly alternative to these loans but rather contribute to the negative impact on these “hardest-hit” consumers.

Credit unions face pressures from regulators, their own boards and sometimes executive management to hit stellar performance statistics that include high ROA, low delinquency/charge-off rates and strong net worth. The problem here is that being a CAMEL 1 or 2 credit union with strong financial performance metrics might mean that the credit union is not stretching to serve the underbanked.

In urban Detroit, while there are excellent credit unions with a presence there, the fact is much like other large urban areas: a drive through the inner city will show AFS providers on nearly every corner and very few traditional depository institution offices, including credit unions.

While the negative stigma on payday lenders might cause credit unions to shun the idea of competing with them, Lisa Servon, author of “The Unbanking of America,” suggests that a growing number of Americans are giving up on traditional banks and relying instead on alternatives, including prepaid debit cards, check-cashing centers and payday lenders. She also suggests that many of these providers are meeting needs that traditional providers have been unwilling to meet.

The growth of payday lending began in 1993 with the founding of Check Into Cash in Cleveland, Tennessee. The industry grew from 500 storefronts to over 22,000 and a total size of $46 billion. Today, payday loan stores nationwide outnumber Starbucks and McDonalds outlets.

In Michigan, the number of payday loan stores has grown to 559 in 2016, generating over $100 million in fees per year. These stores target locations that are more likely to be near lower-income households. Research from the CFPB has found that the average borrower is stuck in 10 loans per year, usually taking out one loan immediately after another. For Michigan specifically, CFPB data indicates that 70 percent of payday loans are taken out on the same day as a previous loan is repaid, and 86 percent of loans are taken out within two weeks of repayment.

Payday loan stores target demographics that are financially vulnerable and not just in urban areas. For instance, in rural Niles, Michigan, where the population is just 11,000 residents, the median household income is $31,000 and 30 percent live below the poverty line. And yet, there are eight payday stores within a two-mile radius.

Recently, U.S. Bank rolled out a payday loan–like product for its customers, lending them up to $1,000 short term, with rates that climb to $15 per $100 borrowed. In 2013, the OCC halted the offering of payday loans by Wells Fargo, Fifth Third and others. However, in 2017, prior restrictions were removed, and in May 2018, the Trump administration began to actively encourage national banks to get into the short-term lending business, arguing that it makes more sense for banks to compete in this sector with lending in a “safer, sound, more economically efficient manner.”

If large money center banks begin to offer payday loans through their huge branch networks, credit unions might get caught flat footed competitively. And to be clear, in my opinion, this shouldn’t be seen as a lucrative lending opportunity for credit unions. I see it as a chance for credit unions to meet important borrowing needs that, coupled with offering financial education, will transition consumer to loans that help them avoid more expensive borrowing fees.

The Michigan Credit Union League continues to oppose legislation in Michigan that would allow more fees, relax protections on debt collection practices and weaken state regulations on payday lenders. The League is also exploring ways for credit unions to offer more affordable payday loans to borrowers while also offering education and bridge services to more consumer-friendly credit union services.

And as mobile banking becomes the primary method of banking for consumers, a growing percentage of payday loans are being done online vs. in check cashing stores. Also consider the explosion of prepaid debit services from providers like Greendot, Walmart Checking (powered by Greendot), SoFi, Paypal, Ally Bank, Bankmobile and others. All of these providers are projecting their services as “more affordable” or “lower fee” than banks for their customers.

In 2004, QCash Financial, a CUSO of Washington State Employees Credit Union, created an automated cloud-based platform to deliver short-term, small-dollar loans to the credit union’s members. The underwriting engine has been tested and proven and does not rely on credit scores but rather behavioral metrics set by the credit union. This solution is customizable for any credit union wishing to use the solution, and it complies with all relevant regulations.

CU Solutions Group has partnered with QCash Financial to market and sell this lending platform to interested credit unions across the country. Additionally, the Michigan Credit Union League sees a real opportunity to use this unique lending tool to help credit unions meet the needs of the underbanked in financially challenged Michigan urban and rural areas like Detroit and Niles.

The advent and dramatic expansion of payday lending in the U.S. is a relatively new phenomenon and should be a wake-up call for credit unions. As banks rediscover this lending opportunity, it would be a mistake for credit unions to ignore these trends.

Also, market moves by companies like Greendot, SoFi, American Express  and Paypal to offer low-cost reloadable debit cards with expansive ATM networks, direct deposit and bill pay capabilities threaten to displace the most vulnerable consumers from traditional consumer-friendly checking accounts and other services offered by credit unions.

Once these same consumers are displaced from banks and credit unions, they may be more vulnerable to predatory lending practices by payday lenders and other less consumer-friendly lenders.

The underbanked population needs the responsible lending practices and low-cost mobile banking services offered by credit unions, especially in the hardest hit urban and rural areas of the U.S.

Credit unions and their support organizations will need to find creative and disruptive strategies for helping these consumers to make smart banking and borrowing decisions with a complement of financial education.

Concepts that could be explored include the ownership of payday loan stores in select areas, complimented by a mobile tool like QCash that could make these types of loans funded by credit unions.

Additionally, a credit union–owned solution like Walmart Checking powered by Greendot would give credit unions a similar product that offers an alternative to traditional checking accounts without having the member be disintermediated to a “non-bank” provider.

These new concepts, alongside credit unions’ existing consumer-friendly offerings, will help them be true players in this growing market of alternative financial service providers.