Four in 10 Americans do not have adequate savings to cover a $400 emergency expense. With this alarming statistic from the Federal Reserve Board, it stands to reason Congress and state governments should be working in a bipartisan way to identify good public policy to improve access to credit for people who need it the most. At the very least, they should not be pushing policies that widen the credit gap, making access to it even more out of reach.
The U.S. House Financial Services Committee, on which U.S. Reps. Dean Phillips and Tom Emmer serve, is looking at a 36 percent rate cap. Sen. Bernie Sanders and Rep. Alexandria Ocasio-Cortez are sponsoring legislation that would create a national 15 percent interest cap. States across the country — like California, Indiana, and Ohio — are also debating rate-cap legislation.
The segment of the population unable to cover emergency expenses is often categorized as “underbanked.” People in this group know they are unlikely to get the credit they need from traditional financial services, and they regularly turn to small-dollar lenders and other alternative sources of credit to make ends meet during financial emergencies.
In doing research for her book “The Unbanking of America,” the University of Pennsylvania’s Lisa Servon found that consumers who turn to small-dollar lenders for high-interest loans are making well-informed choices for their personal financial well-being.
Small-dollar lenders are highly regulated businesses that offer diverse and accessible product lines customized for people with less-than-perfect credit. Small-dollar lenders present one of the few opportunities for people with damaged credit scores or nonexistent credit history to establish prime credit scores and enter the credit community that economically advantaged people enjoy.
Servon and Aaron Klein, a Brookings Institution fellow, have written that a 15% national rate cap would “likely to hurt the people it’s designed to help, driving the market away from consumers with low credit scores.”
Indeed, studies have shown that national and state rate caps on small-dollar loans would have unintended consequences. When policymakers place artificial constraints on credit access, lending to borrowers with means stays steady or increases, but credit “deserts” appear in low-income communities. There is an especially disparate impact on credit access for minority communities, and as the credit access gap grows wider, the economy becomes less diverse and less inclusive.
National and state rate caps would also have an impact on traditional banks that are experimenting with small-dollar credit options for their customers. Last year, U.S. Bank became the first mainstream bank to enter the small-dollar lending space. The bank’s Simple Loan product gives their existing customers an alternative to traditional payday loans whereby consumers can borrow up to $1,000 to cover emergency expenses. The loan carries fees like traditional small-dollar loans and must be repaid in three months. U.S. Bank’s Simple Loan alternative would be at risk under proposed rate caps.
Americans, regardless of income and ethnicity, deserve equal access to credit. There would be no merit to reforms in the small-dollar loan sector if the reforms were to limit access to credit and force consumers seek unregulated, back-alley credit or to bounce a check, to go bankrupt, to pile up debt on a credit card, or to be forced into other, even worse alternatives.
Consumers need protection from unsavory characters who use a consumer’s financial emergency to make a windfall. Minnesotans should call on Reps. Phillips and Emmer to be careful to ensure any reforms do not limit access to credit and force consumers into desperation.
Patrick Rosenstiel is chair of the St. Paul-based Domestic Policy Caucus, a national organization whose mission is to support transparent, public conversations on critical policy issues at the local level.
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Correction: An earlier version of this commentary has been corrected to show that Servan and Klein’s opposition to a rate cap was specifically to a 15% cap.