Meta Payment Systems

Viewpoint: Does Credit Really Need to Be So Complicated? One Banker's Perspective.

June 2008

By Trent Sorbe, Senior Vice President, Meta Payment Systems

The subprime mortgage debacle has brought to the forefront practices by originators and lenders that, at best, only can be described as puzzling and are, more likely, simply exploitative. The proliferation of mortgage products with terms that are hedged on unlikely macroeconomic trends well outside the borrower's control or comprehension demonstrates the competitive disadvantage our most vulnerable consumers face in the consumer credit marketplace.

While not quite as emotionally charged as home foreclosures, parallel practices exist in the unsecured consumer loan industry, as well. Credit cards, payday loans, overdraft protection, and auto lending are rife with bad actors. Like mortgages, too often the most financially damaging products are targeted at our most vulnerable consumers-those with few other credit options and most desperate for a solution to their personal financial crisis. The vacuum created by limited choice and desperation disturbs the balance of negotiation and economic principals of consideration in exchange for utility and value.

For some, the purported answer is to quarantine consumers from the marketplace. However, deprivation and isolation, regardless of its form, seemingly does little other than to memorialize someone's current state or perhaps worsen it. Others trust in a macroeconomic solution whereby the market is left unbridled and free of artificial influences. After all, caveat emptor! These market cavaliers are apparently content in the short run with the lack of a true solution to our nation's consumer credit problems. Fortunately, there are those somewhere in the middle, looking for realistic solutions. In the consumer credit debate, the moderates represent the regular cast of characters: bankers, regulators and advocates (each, admittedly, with its fair share of radicals, as well).

Progress to Date

Unfortunately, progress has been slow to materialize. Regulators continue to watch the marketplace evolve faster than rational regulation, often leaving them unable to respond proactively-opting instead to publicly (albeit reactively) exercise their hammer as a means to demonstrate their seriousness. Perhaps more troubling, in a recent proposal two regulatory agencies have placed themselves squarely in the middle of regulating the cost of subprime credit cards under the auspice of consumer protection. Another regulatory initiative appears to define arbitrarily responsible lending and encourages banks to design programs to fit in this regulatory box, but unfortunately ignores the economic realities of building a truly scalable and competitive alternative to non-bank lenders. None of these positions should be viewed as comforting for those of us with a vested interest in advancing clarity and choice in consumer credit.

Meanwhile, a majority of advocates continue to cling to the illusive sub-36 percent loan program by citing a handful of piecemeal, one-off product examples that will never pose a threat to the three competitive advantages of the non-bank lenders: volume, convenience and simplicity. Prematurely labeling programs as predatory or exploitative solely due to the APR does little more than stifle competition and innovation from new market entrants.

Simplicity and Transparency

But before the banking industry cries foul too loudly, it must also accept its share of responsibility for the credit abyss felt by many of the financially underserved. A cursory review of the current product offerings by banks ably supports that regulators and advocates should not bear all of the blame for banks being replaced on the first few rungs of the financial services ladder. Consumer credit today is dominated by products with terms that are complicated, fee schedules that are indecipherable and obscure billing practices designed to squeeze out every last possible fee. Far too often, the most egregious of these products are targeted to segments of our population least likely to understand them. This misalignment of product structure and audience invites irrational regulation and criticism.

Perhaps more importantly, complication and confusion do little to build trust with the borrower and undoubtedly impact behavior. Terms such as "debt treadmill" and "cycle of debt" are commonly used to describe the phenomenon of customers feeling overwhelmed by the terms of a credit product, forcing many to simply give up and live with the ramifications. Many borrowers in this situation often cite the helplessness associated with fees that they did not understand until it was too late to try to control and the inability to gain traction on the balance owed. While the borrower is the obligated party to repay, creditors must begin to evaluate whether product terms breed disloyalty and nonperformance.

The Last Frontier

The financially underserved is the last frontier for new customer acquisition. It remains the one demographic where banks are not simply acquiring new customers at the expense of their competitors and vice versa, a practice that applies pressure to lending standards and net interest margin. Furthermore, the opportunity becomes larger as we learn more about the demographic. Preliminary data from the Center for Financial Services Innovation indicates that the underserved demographic is larger and more socio-economically diverse than originally thought. (See "CFSI Unveils Initial Results" on page 1.) To competitively enter this marketplace, a foundation must be established. First, the economic reality of small-dollar, subprime credit is that creditors must be free to price for risk. It's difficult to imagine something more counterproductive than an arbitrary pricing ceiling for banks considering such worthwhile initiatives. The potential for regulatory backlash, irrational scrutiny and unknown loss history are often cited by bankers not interested in challenging the grip non-bank lenders have on the small-dollar loan marketplace. Plus, a truly competitive product requires developing a brand, creating a distribution channel, investing in scalable technology platforms and using underwriting models that are still new and relatively untested. These realities are formidable enough, even if bankers felt that they had the freedom to price. Secondly, financial institutions looking to exploit the market vulnerabilities of non-bank lenders should respond with better, more straightforward products. As institutions experiment with competitive solutions, policymakers, regulators and, most importantly, banks should consider the following measures:

1. 1. Consolidate terms that (in aggregate) could negatively impact repayment performance if not properly understood by the borrower.
2. 2. Make the behavior that triggers borrower costs easily understood and under the control of the borrower.
3. 3. Use graphical illustrations to more clearly demonstrate the cost of certain adverse behavior over time.
4. 4. Design graduation programs that are easily understood and attainable, so the borrower can establish a goal for lower cost borrowing.
5. 5. Require that the customer take deliberate action to access credit and tie fees and other costs to that specific action, rather than looking to generate fees by borrower inaction.

Borrowers understand that there is a cost of borrowing, and that cost must be risk based. At the same time, many are faced with a personal financial crisis that prohibits fully researching options for credit. Products that instill knowledge in the borrower and provide them with a sense of control will translate into a stronger bond with the customer and improved performance.

About the Author

Trent Sorbe is senior vice president of credit products at Meta Payment Systems, an issuer of credit and prepaid cards and a leader in small-dollar, microlending. He is responsible for the evaluation, development and administration of all large-scale credit products for Meta, including the organization's patent-pending iAdvance Line of Credit. iAdvance is the first large-scale credit feature tied to an underlying prepaid card relationship, an achievement earning the prepaid card industry's 2007 Most Innovative Product Award. Sorbe joined Meta with more than 15 years of consumer credit and regulatory experience in the banking industry and the FDIC. He is also a Certified Risk Professional and a Certified Regulatory Compliance Manager.