The Overdraft Problem Is Really a Credit Problem

There is growing evidence that consumers who have a need for credit are turning to overdraft because they lack better options. A recent Wall Street Journal investigation of fee income at banks inside retail stores, for example, quoted a customer saying she overdraws “all the time” because the overdraft fee is cheaper than a payday loan.

The fact that some people are forced to choose between overdraft and high-cost payday loans when they experience a shortfall is a clear sign that something is missing in the marketplace. But rather than spending time debating which option is worse for consumers or focusing solely on reining in overdraft, we ought to shift our energies to creating new credit products that meet consumers’ needs transparently and affordably.

Innovating in small-dollar credit is challenging, given the myriad state rules, lack of clear federal guidelines and inherent riskiness of lending to people without a credit history or with damaged credit. Some forward-looking lenders, however, are experimenting with new ways to meet these consumers’ needs, often drawing on technology to minimize risk, reduce the cost of delivery and improve the customer experience.

To support and encourage such experimentation, CFSI recently launched a Small-Dollar Credit Test and Learn Working Group, which convenes five companies that are piloting new credit products or product features that align with many of the quality guidelines in CFSI’s Compass Guide to Small-Dollar Credit. CFSI, with the support of the MetLife Foundation, the Ford Foundation and the Omidyar Network, will partner with working group participants to track their pilots’ outcomes and to share valuable lessons with the rest of the industry. Here’s a snapshot of what the companies are testing:

Regions Bank is piloting changes to its existing savings-secured installment loan that enables customers to borrow with as little as $250 in savings. Since reducing its minimum savings requirement from $2,000 to $250 early this year, Regions has seen demand for the installment loan increase dramatically. Regions aims to better understand what customer need (or needs) this product is meeting and what lessons it has to offer for future high-quality, small-dollar credit product design.

Kinecta Federal Credit Union is piloting a payday consolidation loan that will enable customers to convert multiple outstanding payday loans into a single installment loan. LexisNexis Risk Solutions will partner with Kinecta to provide underwriting data for the loans. Kinecta is testing whether the ability to consolidate multiple payday loans and pay them off over time with affordable monthly payments helps its members to break the cycle of debt.

Emerge Financial Wellness is experimenting with ways to increase take-up and usage of an optional “Save as You Repay” feature, which enables borrowers of its workplace-based installment loan product to contribute additional funds to a savings account each time they make a payment. Emerge aims to identify the most effective ways to help its customers build a cushion against shortfalls, thereby reducing their need for credit in the future.

Enova International is piloting a new feature that enables customers of its online NetCredit Gold product to customize their loan terms and monthly payment amounts. Enova International seeks to gauge whether borrowers will be more successful repaying their loans if they’re able to choose the payment amount that fits their budgets.

We expect that each of these pilots will contribute valuable lessons about what works in small-dollar lending. We hope some will succeed and will be replicated by others in the marketplace.

But innovation also requires the willingness to fail and to learn from that failure. The only way we can understand how to align borrower and lender success in small-dollar lending is by testing and learning, over and over again. We must embrace the philosophy of lean innovation—rapid-testing and customer feedback—if we ever hope to make progress on filling the gap in the market for high-quality small-dollar credit.

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