A core principle of bank lending, known as safety and soundness, dictates that institutions only issue loans that have a high likelihood of repayment. This principle protects both banks and borrowers, ensuring that lenders do not incur unsustainable losses or issue credit irresponsibly and that customers get loans they can afford to repay. Over the most recent year of bank loan data released by the Federal Reserve, annual loss rates—known as charge-off rates—for bank-issued loans came in at 2% or lower, but one category of bank-issued loans—rent-a-bank payday loans—looks quite different.
The filings of the large payday lenders offering these bank-originated loans show that a high share of loans are not being repaid, indicating that their bank partners are lending indiscriminately, with loss rates averaging 50% in 2019 and exceeding that figure this year.
These loans are issued by a half-dozen banks supervised by the Federal Deposit Insurance Corp. (FDIC) on behalf of payday lenders to customers with whom the bank otherwise has no relationship. Normally, payday lenders issue their own loans directly to consumers in accordance with state consumer lending laws. These loans are known for high interest rates and large payments and are used primarily by low- and moderate-income borrowers who are struggling to make ends meet.
But when state consumer safeguards have prevented very high interest rates or other harmful terms, some payday lenders have partnered with banks to avoid the laws of borrowers’ states. Instead, these lenders have said the banking laws of the banks’ home state govern these transactions, which allows them to charge much higher interest rates than would otherwise be permitted. Nevertheless, these loans are subject to general bank lending standards and come under the purview of FDIC supervision.
In June 2022, The Pew Charitable Trusts analyzed the public filings of three large, publicly traded payday lenders that issue a high share of rent-a-bank loans and found that they had annual loss rates in 2019 averaging 50%. That is not unusual for a payday lender, but it is a startling figure for a bank. The same three lenders’ filings released in the fall of 2022 show that their annual loss rates are now averaging 55%, despite other bank-issued loans averaging 2% or lower over the same time.
Even bank and credit union small-dollar loans made to customers with low credit scores have generally had annual loss rates sharply lower than these rent-a-bank loans, and large banks are increasingly making these affordable loans widely available to their customers. Another way of assessing whether lenders are offering credit responsibly is the share of revenue they use to cover losses, which for these three payday lenders issuing rent-a-bank loans is averaging 53% in their most recent filings. That figure also is far higher than the figures normally experienced at banks and means that for every $100 the lenders earn, they are using $53 just to cover losses.
The payday lenders are compensating for those losses with interest rates on these bank-originated loans often exceeding 100% and sometimes topping 200%. In many instances, consumers are charged more in interest and fees than they received in credit, meaning that they owe back more than double what they borrowed.
Current charge-off rates are more than 25 times higher than those for bank credit cards
| Bank credit cards | Rent-a-bank payday loans | |
|---|---|---|
| 2019 annual loss rates | 4% | 50% |
| 2022 annual loss rates | 2% | 55% |
Sources: Federal Reserve Board, “Charge-Off and Delinquency Rates on Loans and Leases at Commercial Banks” (Nov. 2022); Enova International Inc. Form 10-Q (Oct. 28, 2022) and Form 10-K (Feb. 28, 2022); Opportunity Financial LLC Form 10-Q (Nov. 9, 2022); Elevate Credit Inc. Form 10-Q (Nov. 9, 2022) and Form 10-K (Feb. 25, 2022)
Such high charge-offs indicate that the half-dozen small FDIC-supervised banks issuing loans on behalf of payday lenders are continuing to engage in high-risk, high-loss lending. Standard bank supervision principles mean that the banks originating these loans are responsible for their poor outcomes even though they are quickly selling them to their payday loan partners. These loss rates raise serious questions about whether the banks originating payday lenders’ loans are fulfilling the responsibilities that come with their bank charters. For example, the FDIC’s Standards for Safety and Soundness require banks to “establish and maintain prudent credit underwriting practices,” “make an informed lending decision and to assess risk,” “assess the ability of the borrower to repay the indebtedness in a timely manner,” and consider the borrower’s “willingness to repay.”
Annual loss rates of 55% suggest that the banks issuing these high-cost loans are not taking these required steps. The payday lenders’ data also includes loans that they issue directly without bank partners. One company notes that banks currently originate 94% of its loans, suggesting that its overall high loss rates are necessarily similar to those for its rent-a-bank loans. Further, the fact that payday lenders are largely operating without banks where it is legal to do so under state law, but using the banks to originate their loans where it is not, shows that the primary role of the banks is to help the lenders avoid state consumer safeguards. And because these loans’ only reason for not complying with state law is that they are originated by a bank, regulators need to assess them like any other bank credit and engage in standard supervision and examination to ensure that they are being originated in a safe and sound manner. Data from rent-a-bank payday lenders’ most recent public filings indicates that these loans are not.
Alex Horowitz is a principal officer and Chase Hatchett is a senior associate with The Pew Charitable Trusts’ consumer finance project.