Confidential Draft – Feb. 27, 2007 

Memorandum To: Members of the FDIC Advisory Committee for 

Economic Inclusion 

From: Steven O. App 

Deputy to the Chairman and Chief Financial 

 Officer 

Michael H. Krimminger 

Special Advisor for Policy 

Date: February 27, 2007 

Subject: Expanding the Availability of Reasonably-Priced Small 

Dollar Loans: Staff Proposal for a Pilot Project 

Overview 

 

Staff proposes that the FDIC establish a pilot project to demonstrate the commercial viability of 

reasonably-priced small dollar loan products. The proposed project will offer options for 

incentives to banks for participation and a menu of suggested features for small dollar loan 

products to be offered at a reasonable cost to consumers. 

This staff proposal will be presented to the Committee at the March 28, 2007 meeting. At that 

time, we will be seeking your advice and recommendations on the proposal. As a result of the 

open meeting requirements, any written comments you choose to provide in advance must be 

made available to the public. 

Background 

Payday loans are small value, very short-term loans typically extended to consumers with proof 

of employment and a checking account. Security to the lender is provided by a check or debit 

authorization post-dated to the borrower’s next payday. Loans offered through payday loan 

stores typically have two-week terms, an average balance of $250-300, and associated fees of 

around $15-$20 per $100 balance. This structure results in Annual Percentage Rates often in 

excess of 390 percent. Borrowers make an appointment to return to the payday store on their 

payday to repay the loan in full or rollover the loan (or a portion) which results in another round 

of fees. If the customer fails to appear, the payday lender can deposit the check or undertake 

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other collection efforts.1

A major perceived advantage of payday loans to the consumer is the immediate availability of 

funds. The application process is streamlined and credit criteria minimal – often consisting of 

only the proof of employment and a checking account. Payday loan users cite both the 

immediacy of the funds provided along with the desire to avoid potentially more costly bounced 

check fees or vendor late fees. A significant problem with payday loans for consumers, and one 

that appears to be built into the profitability of many payday lenders, is their recurrent use. 

Perhaps 37 percent of borrowers use the products more than twelve times each year. Other 

studies show that 91 percent of payday borrowers use the loans five or more times with the 

average borrower taking out 8-13 payday loans each year. Rolling over payday loans and other 

recurrent use may leave the borrower owing more in fees than the original balance of the payday 

loan. 

The payday loan market has been dominated by rapidly growing stand-alone payday loan stores. 

A few banks, and even more credit unions, have been innovative in developing products that 

offer similar convenience at much more reasonable costs to the consumer and that sometimes 

include a savings component. Most bankers have been reluctant to expand or implement small 

dollar loan programs, citing several concerns: 1) questions about the potential reputation risks; 2) 

perceived regulatory hostility; and 3) skepticism over the business case for such programs. In the 

view of some bankers, the business case for offering affordable, small dollar loans may be 

undercut by comparison with the substantial income earned from fees collected through bounce 

protection programs, credit card loans, and from other, similar charges to consumers. 

The staff proposals for a FDIC-sponsored pilot project are designed to demonstrate the viability 

of such programs as a component of a business plan to reach out to underserved communities, 

develop new customers for mainstream banking services, and reduce consumers’ reliance on 

high-cost, non-bank service providers. 

Research suggests that banks have certain inherent advantages in providing lower cost, small 

dollar loans over payday loan stores. First, banks have the preexisting infrastructure to serve 

these consumers and can avoid the significant fixed costs that opening new, stand-alone payday 

loan stores entails – including advertising, rent, and payroll. Banks, unlike payday loan stores, 

also can recover their fixed costs over a range of products. Estimates suggest that the per-loan 

cost for payday lenders are in the range of $25 for established stores and $36 for stores open less 

than four years.2

 In addition, the cost to make new loans to existing payday loan customers is 

considerably lower than the cost to attract new customers. As a result of these characteristics of 

payday loan stores, loan volume and repeat business are key determinants of payday lender 

profitability. All else being equal, the discussion above would suggest that banks have a cost 

advantage over traditional payday lenders in making small dollar loans and that this could lead to 

lower costs for consumers. 

 

1 See Sheila Bair, “Low-Cost Payday Loans: Opportunities and Obstacles,” Report prepared for the Annie E. Casey 

Foundation at 6-7 (June 2005); Katherine Samolyk & Mark Flannery, “Payday Lending: Assessing the Importance 

of Scale to Store Performance,” Preliminary Draft (October 3, 2006). 

2 See Bair at 28-29; Samolyk & Flannery at 11-12. This includes the costs of loan defaults and collection efforts. 

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Second, banks are in a superior position to minimize credit losses through direct deposit, 

automatic repayment, and the availability of better data about their account holders (such as 

overdraft histories).3

 These features also serve to reduce banks’ per loan expenses for repayment 

compared to payday lenders’ primary reliance on customer traffic for repayment. 

Third, banks can offer a variety of products that build revenue through a longer-term relationship 

with the customer. One issue noted by some studies is that some payday loan borrowers are not 

comfortable seeking credit from banks. Overcoming this negative perception will require 

reaching out to consumers and to community groups to provide a more welcoming environment 

for consumers, as well as to demonstrate the lower cost of banking products. 

Fourth, banks can offer better customer privacy, convenience, and financial growth through 

products in the form of revolving lines of credit linked to deposit accounts. Products such as the 

North Carolina State Employees’ Credit Union’s Salary Advance Loan (SALO) program can be 

building blocks for development of consumer savings. 

A Sample of Successful Small Dollar Loan Programs 

There are a number of examples of successful small dollar loan programs offered by banks and 

credit unions. Among these innovative programs is the North Carolina State Employees’ Credit 

Union’s SALO program, which provides members with direct deposited paychecks with loans up 

to $500 for no fees, an APR of 12 percent and repayment at the next pay date. Perhaps most 

valuable in promoting savings and wealth generation, each time a SALO loan is granted, 5 

percent of the advance is deposited into the SALO Cash Account and accumulates interest at 

passbook rates. This both reduces credit risk (by partially securing the advanced funds) and 

encourages the member to save. Rollovers of existing SALO loans actually increase both the 

credit union’s collateral and the consumer’s savings. The SALO program has partnered with 

BALANCE, a consumer credit counseling service available free to credit union members. After 

three SALO loans, the credit union will recommend that the member receives counseling from 

BALANCE. 

This is only one example. Banks, such as Austin Bank of Chicago and LaSalle Bank of Chicago, 

offer similar products. Some larger banks, such as Citibank, offer revolving lines of credit that 

are accessed if the customer overdraws their account or needs extra cash. The line of credit has a 

$5.00 annual fee and bears a maximum interest rate of 20.25 percent (in New York) and lower in 

other states. Balances are repaid in monthly deductions at 1/60th of the balance (minimum 

$10.00) from customers’ checking accounts.4

 There are other examples, but it is unfortunate that 

more financial institutions do not offer reasonably-priced payday loan alternatives. 

Some state governments have sought to provide incentives to encourage development of small 

dollar loan programs by banks and other credit institutions. One recent example is the “Better 

 

3 Federal Reserve Regulation E prohibits requiring automatic repayment by electronic means on a preauthorized, 

recurring basis, but the regulation does allow banks to offer financial incentives to encourage the use of automatic 

repayment. 

4 For other examples, please review those noted on the website of the Center for Responsible Lending at 

www.responsiblelending.org. 

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Choice” program initiated in 2006 by the Pennsylvania State Treasurer with support from the 

Pennsylvania Department of Banking and the Pennsylvania Credit Union Association (PCUA). 

Under the program, participating credit unions offer 90-day loans of up to $500 with a savings 

component of an additional 10 percent of the loan balance deposited into a savings account. The 

loans have application fees capped at $25 regardless of loan size and interest rates cannot exceed 

18 percent. Rollover loans are not permitted and the funds in this savings account cannot be 

withdrawn until the loan is repaid. The longer terms of the Better Choice loans as well as the 

savings component help encourage asset growth by credit union members. An additional feature 

that supports prudent financial decision-making is the requirement that participating credit 

unions offer financial counseling to borrowers. 

In order to encourage participation, the Pennsylvania Treasurer deposited $20 million of state 

funds in the PCUA’s credit union. The PCUA chose this option because its members did not 

want to manage smaller deposits in individual credit unions. While the program is now just 

getting underway, more than 45 credit unions in Pennsylvania have agreed to participate. 

Although designed to achieve broader objectives, another example of a creative approach to 

making reasonably-priced banking services more available is the “Enriched Banking 

Development District” program in New York. Although the program predated her tenure as New 

York State Banking Commissioner, Diana Taylor was instrumental in developing and expanding 

the program. In late 2004, she formed the Banking Development Working Group and included 

members from New York City and State governments along with community development 

experts. The Working Group sought to expand access to banking in specific communities by 

providing incentives for banks to open branches with products and services to meet the 

communities’ specific needs. In short, the “Enriched Banking Development District” program 

provides public deposits from New York City and New York State at below market rates along 

with other at-market public deposits. Other available public incentives include property and other 

tax breaks, favorable CRA consideration, assistance in locating branch sites, and other 

incentives. Banks seeking to participate in the program must apply to the NYS Banking 

Department and define specific products and services that will meeting community needs not 

currently served by other financial institutions. The program appears to have achieved significant 

successes. Branches opened under the program have been actively involved in providing 

financial literacy training and have introduced new services and products, including new ATMs, 

free application assistance for Earned Income Tax Credits, and extended hours, to meet 

community needs. The program has now been expanded throughout New York state. 

FDIC Draft Small Dollar Loan Guidance 

On December 4, 2006, the FDIC issued for comment guidelines to state non-member banks to 

encourage them to offer affordable small-dollar loan products. FDIC-supervised institutions that 

offer these products in a responsible, safe and sound manner may receive favorable consideration 

under CRA. The draft guidance suggests ways the banking industry can make affordable shortterm loan products more accessible to these customers, helping to build long-term, profitable 

multiple-account relationships. In the proposed guidance, the FDIC encourages banks to offer 

products with affordable, reasonable interest rates with no or low fees; repayment schedules that 

pay down the principal balance of the loan; and a savings component incorporated into the loan 

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product. In addition to a savings component, banks are encouraged to include financial education 

for frequent borrowers. The FDIC also encouraged banks to leverage technology in managing 

these products. 

The comment period on the guidelines expired on February 2nd. A review of those comments 

demonstrates broad support for the guidelines, including a limitation on interest rates for such 

products. Most commenters also agreed that small-dollar loan products should provide an 

affordable installment repayment schedule longer than a single paycheck cycle, minimal or no 

fees, and a savings component. The FDIC anticipates finalizing the guidance during the 2nd

quarter of 2007. 

Military Lending Conference 

On December 6, 2006, the FDIC hosted a conference, entitled “Affordable, Responsible Loans 

for the Military: Programs and Prototypes,” with bankers and community groups focused on 

meeting the needs of military personnel and their families. The enactment of the Talent-Nelson 

amendment earlier in 2006 highlighted growing concern about the impact on our military 

personnel of frequent use of high-cost providers for short-term loans and other financial services. 

The banks that attended the conference developed a template for an affordable, small 

denomination loan product with a savings component. The template provides for loan amounts 

up to $1,000 with repayment periods of up to one year, interest rates in the 12-18 percent range, 

no prepayment penalties, and low or no origination fees. The template also includes a mandatory, 

accumulating savings component of 5 percent or more of each payment to build assets and 

sources of future repayment along with direct deposit of some or all of the borrower’s paycheck. 

An additional feature of the template is strong encouragement for financial institutions to provide 

financial education to service members and their families. These features already provide a 

number of banks focused on the military market with profitable products and, more importantly, 

with growing longer-term relationships with borrowers. We believe that loans with the features 

in the template developed at the Conference can be viable components of responsible lending to 

all borrowers. 

Outline of Staff Proposal for FDIC Pilot Project: 

The following staff proposal for a pilot project to demonstrate the value to banks of 

incorporating reasonably-priced small dollar lending programs into their consumer product 

offerings is designed around several key elements: 

• Participating institutions would serve as depositories for FDIC deposits at market or 

below market rates. If FDIC deposits are made available, staff proposes that the FDIC 

consider making available up to $30 million from current overnight accounts for deposit 

in participating institutions. 

• Participating institutions would warrant favorable consideration under the Community 

Reinvestment Act as an activity responsive to the credit needs of the community. 

• Banks interested in participating will be selected based on a simple, transparent, and 

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streamlined process using objective criteria. 

• The FDIC will verify adherence to the guidelines for the lending program as part of its 

normal examination process to limit any burden on participating banks. 

• The project will provide a small dollar loan template that will allow participating banks to 

exercise considerable flexibility in designing a program that best meets their needs. 

Several of the possible options that may be selected by banks are described below. These 

options, however, are not meant to be an exhaustive list. We recommend that the FDIC 

should encourage innovation and experimentation within the parameters of the template 

guidelines. 

There are additional features that are recommended by the literature and by discussions with 

researchers and other interested parties. First, outreach will be crucial. Discussions with a 

number of individuals emphasized the key element of outreach to underserved communities and 

the role that community groups can play in success of the pilot. Our relationships with 

community groups could be crucial to getting the word out about the project and its benefits to 

consumers. 

Second, a variation on this approach would use “community groups” of bankers by seeking to 

develop a partnership with a banking trade organization. Some trade groups have separate 

corporate organizations designed to provide services to members that could serve as vehicles to 

administer the pilot. This approach could be similar to that used in the “Better Choice” initiative 

in Pennsylvania – a deposit from the State Treasury was placed into the credit union for the 

Pennsylvania Credit Union Association and used as seed money to support credit unions 

participating in the payday loan alternative. 

Possible Incentives for Participating Banks 

The principal challenge in developing a successful pilot for small dollar loan programs is 

determining the appropriate level and mix of incentives that will encourage bankers’ 

participation, but also will not impair the demonstration to the banking industry of the 

commercial viability of affordable small dollar loan products. That is, if the incentives we offer 

are deemed too generous by objective observers, they will attribute any program success to the 

deposit earnings subsidy or CRA credits, rather than to the commercial viability of the small 

dollar loans. 

Discussions with researchers and bank representatives indicate that a “menu” approach for 

incentives may be the most useful because, for example, below market deposits may be more 

important for some institutions, while CRA credit may be more important for others. Other banks 

may prefer to participate by providing funds (either directly or through FDIC-placed funds) to an 

“administrative” bank that makes and manages the loans. An a la carte approach for 

participating banks will give them some flexibility to design the optimal package of incentives. 

Staff seeks the advice of the Committee on the level of incentives that may be appropriate to 

encourage participation by banks in the pilot project. One possible incentive is the placement of 

FDIC funds in participating banks either at market or below market rates of return. Staff would 

prefer to offer such funds at current market rates for 2-year funds, but would appreciate the 

Committee’s views on whether this will encourage adequate participation in the pilot. 

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Alternatively, the FDIC could provide an incentive similar to that used in New York’s Enriched 

Banking Development District program and Pennsylvania’s Better Choice program. This would 

entail the placement of FDIC funds in the participating banks at below market rates. To protect 

the security of the funds, all deposits in excess of $100,000 would be collateralized. For 

example, the FDIC could offer the funds to participating banks as a 2-year commitment at 2-3 

percent below current market rates for funds deposited for similar terms. To provide some 

context on the rates currently paid by insured institutions, a review of certificate of deposit rates 

as of February 27, 2007 reveals a wide range with internet rates ranging to 5.26 percent for 2-

year CDs in excess of $95,000 while some more community-based banks report rates in the 

range of 4.11 to 5.12 percent. Bankrate.com reports the average annual percentage yield 

nationwide is 5.03 percent.5 Based on the state government experience, this incentive will 

encourage participation by providing lower cost funding through a stable two-year deposit. 

As noted above, participating banks also would receive favorable consideration under the 

Community Reinvestment Act for engaging in an activity responsive to the credit needs of the 

community.6

Staff also recommends that the pilot project consider applications both from single institutions 

and from consortia of institutions, who may agree to pool the proffered deposits and share the 

resulting incentives. The pooling of resources may allow multiple banks to offer small dollar 

loans through a single, community-based institution, a so-called administering bank, and may 

also allow more rapid expansion of such products in underserved communities. This approach 

may increase the size of the lending program without requiring additional collateral to be 

pledged by the administering bank since the FDIC’s funds would be separately insured at the 

other members of the consortium. 

A similar pooling approach is used by the Community Investment Corporation (CIC) in Chicago 

to promote the availability of mortgages in underserved communities. This approach involves 

four steps: 1) investors pledge funds, 2) CIC issues mortgages, 3) CIC sells notes to investors 

who are now obligated to purchase, and 4) investors share in revenue stream and CRA benefits. 

This model could be used for bank “investors” for small dollar loans and the purchase of note 

interests would ensure that the “administering” bank did not have to bear full exposure on 

resulting assets. This approach has been used in a number of programs, such as affordable 

housing, dating back to the 1970s and will be used in the Alliance for Economic Inclusion (AEI).

 

5 Information reported was identified in a search of Internet information on February 27, 2007. Community-based 

bank rates reflect reported information for institutions based in Chicago, Illinois (LaSalle Bank, Harris Bank, and 

Liberty Bank for Savings). 

6 See Interagency Questions and Answers on the Community Reinvestment Act, 66 Fed. Reg. 36619, 36631, 

Sec.345.22(a)-1 (July 12, 2001), http://www.fdic.gov/news/news/financial/2001/fil0164.html. The federal banking 

agencies confirmed that establishing loan programs that provide small, unsecured consumer loans in a safe and 

sound manner (i.e., based on the borrower’s ability to repay) and with reasonable terms may warrant favorable 

consideration as activities that are responsive to the needs of the institution’s assessment area(s). While this 

clarification refers to the CRA lending test for large institutions (institutions with assets over $1 billion), the FDIC 

takes a similar view for all other institutions. 

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Suggested Features for Affordable Small Dollar Loans for the Pilot Project 

The staff proposal for a pilot project seeks to harness the creativity of bankers by allowing 

participating institutions to design individualized small dollar loan programs within broad 

parameters laid out by the FDIC. As a consequence, participating institutions should be 

encouraged to design a program that incorporates certain key features but offers the institution 

flexibility in their specific content and implementation. As described below, staff recommends 

that the FDIC evaluate and select applying institutions for participation that offer optimal 

combinations of these suggested features. 

Building on the principles identified in the FDIC’s Small Dollar Loan Guidance and on the input 

provided by participants at the FDIC’s recent military lending conference, staff recommends that 

the FDIC seek applications by institutions that propose programs with the following broad 

features: 

Loan Amount – up to $1,000. Most short term “emergency” loans are in the $500 range, but 

higher loan amounts may be permissible with further underwriting. There also are a number of 

options for delivery of the loan funds. Among the possibilities are normal consumer loans and 

lines of credit. 

Amortization period – Longer than a single pay cycle and up to 12 months. Affordable, 

amortizing payments made over a suitable period of time (1) are preferable to repeated, 

consecutive and increasingly costly loan balance renewals that may occur with payday or other 

loans, and (2) provide the bank with an extended opportunity to cross-sell asset-building 

products beneficial to both the customer and the bank. 

Interest Rate – Below 36 percent APR. The experience of several lenders at the military 

conference indicated that products with interest rates between 12 and 18 percent offered some 

initial profit, but more importantly lower rates fostered the beginning of a profitable, long-term, 

multiple-account relationship. 

No prepayment penalty. The loan amount is small, the term is relatively short, and it is held in 

the bank’s consumer loan portfolio. There is no call for a prepayment penalty. 

Low or No Origination Fee. A reasonable and low-cost origination fee may help to cover costs 

in some cases, but in any event should bear a direct relationship to actual origination costs. In 

other cases, an origination fee may not be necessary or desirable. 

Mandatory Savings Component – 5 percent or more of the loan payment. A steady increase in 

savings with a tandem reduction in debt (1) provides the borrower with a source of a payment if 

a payment can not otherwise be made, (2) builds assets and a financial cushion to meet future 

emergency needs without borrowing, and (3) provides the bank with an anchor to continue the 

customer relationship after the loan is repaid. 

Direct Deposit & Internet or Telephone Banking. A checking or statement savings account with 

direct deposit of some or all pay, and the ability of the borrower to transfer payments from the 

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account to the loan by internet or telephone, provides (1) convenience to customers, (2) improves 

the likelihood of timely repayment to the bank, and (3) locks in a profitable, long-term customer 

relationship. 

Prompt Loan Application Processing. The application and approval process should take no 

longer than it takes a payday lender to make a pay day loan. An automated application, approval, 

and loan disbursement process would provide fast service to customers as well as lower an 

institution's origination costs. Existing deposit customers may already have been screened by the 

institution's customer due diligence program and, as a result, detailed underwriting may be 

unnecessary. Seasoned customers may be pre-screened for a small closed-end, amortizing credit, 

or a small open-end line of credit with amortizing monthly payments. Current “leave and 

earnings” statements should be readily available for employment and income verification. 

Financial Education and Asset-Building. Financial institutions also should make every effort to 

provide financial education to customers requesting small-dollar loans. Improving financial skills 

can help consumers reduce reliance on short-term, emergency credit and build savings and other 

account relationships. The FDIC’s Money Smart program and similar financial education 

resources are examples. Moreover, institutions that monitor borrower use of credit, and offer 

financial counseling or education when signs of financial stress are detected, will help them 

become better customers. 

Project Administration and Selection Criteria 

Staff recommends that project administration be kept simple, but include four elements: (1) a 

defined application process for participating banks, (2) an approval process, (3) a disbursement 

process, and (4) a monitoring process. In doing so, it is essential that these processes be 

streamlined, automated, and accompanied by appropriate controls to ensure the cost of the 

project is minimized, and that it meets the project’s stated objectives. 

Application Process for Participating Banks. The application process must be simple, 

transparent, and accessible to ensure a wide range of eligible institutions apply. The approval 

criteria for selection of participating banks must be clearly defined and objectively applied to 

ensure the process can withstand external scrutiny. 

We recommend that all applicants should be highly rated and well-capitalized institutions. In 

addition, all applicants should affirm that: (1) similar products are not available in the local 

lending market (because our project should not compete with small dollar, lower cost loan 

products offered by other federally-insured banks), and (2) their loan product will meet consumer 

credit needs at a reasonable cost. 

Approval Process. The approval criteria for selection of participating banks must be clearly 

defined and objectively applied to ensure fairness and reliability. Applying banks should be 

evaluated and selected based on the inclusion of key elements of the suggested features for small 

dollar loan programs identified above. The inclusion of each element will award the applicant 

one point and selection will be based on total points. This will provide identifiable and objective 

selection criteria. 

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In order to promote applications and participation by a diverse group of insured banks and thrifts, 

we recommend that a cap be placed on the amount of funds that may be provided to any one 

institution. 

Disbursement of Funds. To ensure the ongoing integrity of the project, the disbursement of 

FDIC funds to participating banks and approval processes must be segregated within the FDIC. 

Monitoring. Finally, staff recommends that the FDIC should set up a simple monitoring process 

to ensure the participating banks are adhering to the guidelines of the project and to gauge its 

success in achieving its objectives. This could take the form of direct review by FDIC 

employees, oversight by a third party contractor, or through some type of self reporting by the 

participating banks themselves. 

Questions for Committee Consideration and Discussion:

Staff requests that the Committee members consider and provide advice on the proposed pilot 

project. In particular, staff requests consideration by the Committee members of the following 

issues: 

Proposed Incentives: 

• What level or mix of incentives will encourage active participation in the pilot project by 

a diversity of banks? 

• Will the deposit of FDIC funds at market rates be an effective incentive? Is it necessary 

to provide the deposits at below market rates? 

• Will the requirement of collateralization be a significant disincentive? 

• Will favorable Community Reinvestment Act consideration be a valuable incentive for 

participation by bankers? What additional options should be explored? 

• Are the proposed incentives too generous? Will they be viewed as impairing the 

demonstration that reasonably-priced small dollar loan programs are viable parts of a 

bank’s business plan? 

• Does the proposed use of up to $30 million in FDIC funds for deposit over a two-year 

period provide the optimal size and scope for the project? 

Pilot Program Features: 

• Do you suggest any changes to the proposed features for small dollar loan programs 

identified on pages 8 and 9? 

• Are there other features for small dollar loan programs that should be included? 

• There are a variety of options for delivery of small dollar loans to consumers. Among the 

possibilities are normal consumer loans, credit cards, and lines of credit. Should the 

program be limited to specific types of delivery methods? 

• Do these features provide sufficient or too much flexibility for small dollar loan programs 

under the pilot project? 

• Should applications be considered both from single institutions and consortia of 

institutions? 

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Administration: 

• Are there other criteria that should be applied for selection of participating institutions? 

Communications: 

• What are the optimal ways to communicate the FDIC’s goals and interests in promoting 

the pilot project? 

• What are the optimal ways to communicate the FDIC’s goals and interests in promoting 

expanded availability of reasonably-priced small dollar loan programs at banks? 

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