The Federal Deposit Insurance Corporation announced yesterday that it has developed what has so far eluded financial-services innovators in the private sector: a low-cost replacement for payday loans. From the press release:

FDIC's Small-dollar Loan Pilot Shows Banks Can Offer Alternatives to High-cost, Short-term Credit; Results in Safe, Affordable and Feasible Template for Small-dollar Loans

A report issued today by the Federal Deposit Insurance Corporation (FDIC) highlights final results of the FDIC's small-dollar loan pilot program. The pilot, launched in 2008, was a two-year case study designed to illustrate how banks can profitably offer affordable small-dollar loans as an alternative to high-cost credit products, such as payday loans and fee-based overdraft programs.

All hail the FDIC! A product that lets banks “profitably offer affordable small-dollar loans as an alternative to high-cost credit products, such as payday loans” is not to be sneezed at. And on the numbers, the product the FDIC has come up with fits the bill. Maximum APR, for instance, is 36% rather than the 450% or higher annual rates payday lenders typically charge. Loan amounts can be up to $2,500, more than enough for the typical short-term borrower’s needs. The minimum loan term, meanwhile, is just 90 days. 

So the FDIC really seems to have come up with a breakthr-- . . . . Say, hold on, what’s that press release headline say again? The loans are “safe, affordable, and feasible.” Haven’t they left something out? I know!  “Profitable.” The loans are profitable, too, right? If the guarantor of the nation’s bank deposits is going to go to all the time and effort to design a new lending product for the banking industry, that product won’t lose the banks money, right? Right?

Alas, the world is not so perfect, after all. “[G]iven the small size of [small dollar loans],” reports an article in the FDIC Quarterly that accompanied the press release, “.   .  . the interest and fees generated are not always sufficient to achieve robust short-term profitability. Rather, most pilot bankers sought to generate long-term profitability through volume and by using small-dollar loans to cross-sell additional products.” 

Oh. So the FDIC’s small-dollar loan is a money-loser for the banks. And the agency is urging them to offer it to consumers anyway. Interesting.  

What’s more (now that I’m wading down here in the fine print), on close inspection, the FDIC’s product doesn’t really stand in for the payday loan it’s designed to replace. Approval usually takes 24 hours, for instance—too late to serve the very pressing needs of most payday borrowers. And in underwriting, the lender pulls a credit report in addition to verifying the borrower’s ID and income. All that payday lenders usually require, by contrast, are ID, checking account info, and a pay stub. And most important, payday lenders come up with the cash on the spot. So the “alternative to high-cost credit products” the FDIC has come up with is really no alternative at all—and is unprofitable, to boot.

I don’t mean to beat up on poor Sheila Bair and her agency with all this. Rather, my point is—and I hope the FDIC sort of understands this by now, after two years developing a consumer-loan product that can be counted on to not make money—there’s a reason payday lenders charge the rates that they do. For all the vilification payday lenders get, they provide a valuable financial service, economically. Suppose I’m a cash-strapped consumer and my $100 utility bill is due tomorrow. I can either a) pay the bill late and incur a late fee of, say, $20, b) intentionally write a bad check and be hit with NSF charge of $29 (and break the law, to boot), or c) visit a payday lender and borrow the $100 with a promise to repay $115 next pay period. 

What should I do? What would you do?

(What’s more, the financial reform bill that just came out of conference will, by the way, put our hypothetical squeezed consumer in an even tougher position than he is now. Everything from the Consumer Financial Protection Agency, to the Volcker Rule, to the bill’s lack of preemption of state regulation will, as a practical matter, make credit less available and will drive up its price.) 

Having spent two years devising a lending product that is manifestly unworkable, Sheila Bair and her minions must by now, hopefully, have an understanding of some of the hows and whys that go into pricing for risk. If they do, that’s actually a very good thing for the banks—even if they misbegotten small-dollar loan product they have devised is not.

What do you think? Let me know!