Sanders, Ocasio-Cortez interest rate plan has credit unions sweating
Credit unions are warning that a proposal from Sen. Bernie Sanders and Rep. Alexandria Ocasio-Cortez would significantly reduce access to financial services.
Sanders, I-Vt., and Ocasio-Cortez, D-N.Y., introduced their Stop Loan Sharks Act in mid-May, a policy proposal that would cap interest rates at 15% for consumer loans, including credit cards and payday loans. But some credit union executives are wary of the measure, noting that interest rate regulation could also limit options for borrowers, especially for those categorized as high risk.
“I think it’s going to actually reduce access,” said Todd Marksberry, president and CEO of the $2.6 billion-asset Canvas Credit Union in Lone Tree, Colo. “If legislators want to speak to how we’re pricing our product, then strategically speaking financial institutions are going to have to figure out how to still run their business and figure out as a not-for-profit cooperative how to build net worth, manage charge-offs and delinquencies.”
“If they’re going to tell us how to price, they’re going to have to make adjustments in our business model accordingly,” he added.
Credit unions generally charge more for products like credit cards and payday alternative loans because the credit is unsecured. The interest rate could be even higher if the borrower’s credit score is not prime.
Capping interest rates on all consumer credit at 15% would limit credit unions’ ability to price for this risk. That would then greatly disrupt the credit card market and effectively end small-dollar short-term loans, experts said.
But credit unions are also already subject to a limit on what they can charge in interest. The Federal Credit Union Act caps interest rates on most loans from federal credit unions at 15%. However, the National Credit Union Administration board can raise that limit for 18-month periods to ensure the safety and soundness of the industry.
The current cap of 18% has been in place since May 1987, and NCUA has extended it until March 2020. That rate applies to all loans from federal credit unions, except those made through the payday alternative lending program. Those loans can have an interest rate up to 28%.
Over 65% of federal credit unions were providing loan products that would be impacted by lowering the cap on interest rates at the end of the third quarter in 2016, according to an NCUA action bulletin in February 2017.
Credit cards are an important business line for the industry with more than 5,000 financial institutions, including credit unions, offering this product, according to a 2018 report from the Federal Reserve on the profitability of credit card operations. The average credit card interest rate available to those with excellent credit is 14.41%, compared with 22.57% for those with fair credit, according to a WalletHub study.
Given that those with excellent credit are already near the proposed 15% interest rate cap from Sanders and Ocasio-Cortez, it's possible that credit unions may no longer serve those with poor credit because of the risk of default, said Phil Magness, senior fellow at the American Institute of Economic Research.
“And it will also squeeze out smaller institutions who won’t be able to absorb that hit, so a lot of the credit unions, community banks and local institutions will likely be the ones harmed,” he added. This is a "heavily politicized investment vehicle that tilts in the favor of the rich."
The payday loan industry would likely be effectively eliminated by the 15% cap. Payday loans on average carry a 391% annual percentage rate, according to the Center for Responsible Lending. At least some credit unions would probably also stop providing payday alternative loans if they could no longer charge up to 28% for these loans.
The proposed 15% cap is “not compatible with the spirit of the times,” said Rutger van Faassen, vice president of consumer lending at Informa Financial Intelligence, which provides financial research. Instead it would be better to provide more financial education so consumers make more informed decisions, he added.
Still, it seems as if Sanders and Ocasio-Cortez have tapped into public frustration at payday loans, which are often seen as predatory. Three out of four Americans want payday loans to be more regulated, and 72% of payday loan borrowers want the product to be further regulated, according to a survey by the Pew Charitable Trusts.
“The reality is that today’s modern-day loan sharks are no longer lurking on street corners breaking kneecaps to collect their payments,” Sanders said in a statement announcing the joint proposal. “They wear three-piece suits and work on Wall Street, where they make hundreds of millions in total compensation and head financial institutions like JPMorgan Chase, Citigroup, Bank of America and American Express.”
Ocasio-Cortez echoed Sanders’ remarks, noting that rates higher than 15% are “predatory debt traps designed to keep working families underwater.”
But the interest rate cap would likely leave a gap in financial services. Sanders and Ocasio-Cortez proposed using the U.S. Postal Service to fill that void.
Postal banking isn’t a novel concept. In fact, it’s been around for decades having been established in 1911. It also witnessed a usage surge during the Great Depression as depositors sought out a reliable place for their money. However, postal banking was terminated by law in 1966 and officially ended in 1967.
Since then, the possibility of reinstituting postal banking has been kicked around a number of times. Two presidential hopefuls, Sen. Kirsten Gillibrand, D-N.Y., and Sen. Elizabeth Warren, D-Mass., also introduced proposals that would utilize the 30,000 post offices to offer banking services. A report issued last year by the Trump administration found that the postal service was ill equipped to manage the risks involved with providing banking services.
The idea of postal banking is one that looks good 30 feet above, said Will Yarborough, CEO of U. S. Postal Service Federal Credit Union and a board member of the National Council of Postal Credit Unions. But it would create competition that would undercut credit unions in general and postal credit unions specifically. There are already a number of credit unions that operate inside post offices.
“We could lose potentially some of our space in terms of us providing access and convenience on the work sight to postal employees, so we would certainly not want to lose that nor would the postal employees want to lose that,” Yarborough said.
Yarborough also noted that the postal service has limited resources, and that the skill sets needed to work in financial services are not complementary to the expertise developed in working in a postal environment.
“I think that the United States Postal Service is good at moving our mail, [but] to say that they would be great at financial services and car loans and mortgages and checking accounts is probably a stretch,” said Canvas Credit Union’s Marksberry.