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For years, advocacy groups have bemoaned the steep fees and high interest rates of payday loans, which regularly wind up costing consumers a whopping 400% in interest every year. With so much money to be made, many advocates wonder why banks haven’t tried to compete with loans of their own, which would offer them increased profits while giving consumers better loans from more reputable institutions.

The answer, apparently: Banks simply don’t want to. In testimony before Congress this week, two federal regulators explained that for most banks, the financial and reputational risks of small-dollar consumer loans loom larger than any potential profits.

That reluctance is frustrating to regulators, since banks could make sustainable, small-dollar loans if they chose to.

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“The FDIC believes that banks already have the tools and infrastructure to create small-dollar credit products that are both affordable for consumers and beneficial for banks,” Robert Mooney, deputy director of consumer protection for the FDIC, told the Congressional subcommittee on financial institutions and consumer credit last week.

A generation ago, banks offered plenty of such small loans to consumers, usually with reasonable interest rates, Mooney said. But as other companies crowded into the market offering high-cost alternatives like payday loans, auto title loans, pawn shop credit and even credit cards, many banks abandoned the small loan market entirely, Mooney said.

Both the FDIC and the Office of the Comptroller of the Currency have a number of programs aimed at luring banks back into the market. While some banks have participated, the programs have not sparked any broader change of strategy.

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That leaves consumers, especially people with low incomes and no bank accounts, prey to the exorbitant interest rates and fees charged by unregulated lenders like payday loans, said Gerri Guzman, executive director of the Consumer Rights Coalition.

“The fact is people will always come up short from time to time,” Guzman said in her testimony. “If access to one product is eliminated, consumers will seek out another. And it will likely be a more expensive and credit-damaging option.”

The Center for Financial Services Innovation has done some of the most in-depth research on the subject of payday loan alternatives, and Melissa Koide, the group’s policy director, provided the most detailed suggestions for goading banks into giving out small-dollar loans. One would be using the new Consumer Financial Protection Bureau to crack down on predatory practices by high-cost lenders, which have used their high profit margins to squeeze more legitimate companies out of the market.

In addition to supporting the bureau’s work, Koide said, Congress should create ways for low-income consumers to use their monthly payments on things like rent and utilities to help establish better credit. That way, banks would have more information to use in deciding whether people have a reasonable chance of repaying small loans.

The goal, Koide testified, should be to help “consumers meet short-term financial needs while building positive credit records.”

[Related article: Using Your Options During a Financial Crisis]

Image: Chika Watanabe, via Flickr.com

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