The Dynamics of Market Credit for Low End Consumers

A recent Wall Street Journal article examined how the Feds' use of low interest rate policies has failed to reach those in need the most. Aptly calling it the “credit divide,” the article finds that “Fed officials have been frustrated in the past year that low interest rate policies haven’t reached enough Americans to spur stronger growth, the way economics textbooks say low rates should.” That conclusion is of no surprise to many, especially to the 73 million unbanked and underbanked Americans who don’t even figure into the Feds’ equation. That’s because extending credit to these individuals has never been seen as a meaningful contributing factor to the overall health of the economy. Sure there have been special initiatives like the FDIC’s small dollar loan program a few years back, which by all measurable accounts failed. Not because banks weren’t willing to participate in the pilot program, but at the end of the day, without FDIC incentives banks simply couldn’t make money.

Yet, we have 73 million men and women who live with the constant fear that a financial hiccup will trigger a need for money that they don’t have and most likely can’t get. While the Feds are making easy money, it’s going to those with near perfect credit scores which leave many of these 73 million Americans scrambling for other options. In other words, while interest rates are at an all time low, money still isn’t available to those that need it the most.

In a recent study, Serving Consumers’ Needs for Loans in the 21st Century, author Michael Flores finds that neither banks nor alternative financial services providers are extending loans in the $750 to $5,000 range. It’s not complicated to understand, despite benefiting from the Feds’ easy money, loans of under $5,000 simply aren’t profitable for banks. Even if such loans were to exist, many customers wouldn’t qualify. On the other hand, alternative financial services (AFS) providers can’t fill the space because of the burdensome costs of complying with 50 distinct sets of state regulations.

Still, Mr. Flores suggests that it is AFS providers who are in a better position to extend credit to low- to-moderate-income consumers because they have built a more efficient and technology-driven model, that is if regulators can come up with a new banking model. The alternative financial services market is currently limited mostly to payday loans, pawn, or title. With the right regulatory framework, however, AFS providers are capable of expanding into longer-term credit options better suited for many consumers’ needs.