Banks should not be using the benefit of low-cost capital made available to them by their status as regulated institutions to fund businesses that extend harmful high-cost lending products. Let hedge funds, venture capitalists, and other nonbank sources provide that capital.

Reinvestment Partners, my nonprofit advocacy group in North Carolina, is releasing a report Monday that documents $5.5 billion in loans made by banks to a variety of publicly-traded high-cost consumer finance companies. By following the money, our paper reveals the close relationship between some of our nation’s largest financial institutions and the fringe lenders that populate storefronts in neighborhoods across America.

Some would decry the idea of divestiture on the grounds that business and morality should not intersect. But from a social cost-benefit analysis, the costs inflicted upon working-class households in America far outweigh any of the financial benefits reaped by the lenders.

Leaders of consumer-facing companies make a mistake when they ignore any risk to their brand. This is one of the cases where business and morality do intersect. After all, it is not as if banks are making big profits by participating in this business. Right now, the average interest rate on debt extended to payday lenders and their brethren by some of the nation’s largest banks is only slightly more than 5%. On an after-tax basis, the spectrum of nonbanks identified in our paper fund their operations at a weighted average cost of capital of approximately 6.2%.

Significantly, consumers see no gains from the extension of so much corporate debt at these low rates. Some of the retail storefront payday lenders financed by these banks lend those dollars back out to the community at rates of as high as 500%.

This type of behavior is a net loss that outweighs many of the good things that banks do elsewhere in communities.

The relationships between banks and questionable operators do not end with corporate lending. Many high-cost nonbank lenders have individuals on their boards who currently or previously worked for large banks and investment houses.

High-cost consumer finance companies mentioned in our report make it explicitly clear that they need these loans. Consider a statement made recently by QC Holdings, a Kansas corporation whose subsidiaries offer payday loans, installment loans, and car title loans:

We depend on borrowings under our revolving credit facility to fund loans, capital expenditures, smaller acquisitions, cash dividends and other needs. If consumer banks decide not to lend money to companies in our industry or to us, our ability to borrow at competitive interest rates (or at all), our ability to operate our business and our cash availability would likely be adversely affected.

The shame of it all is that these banks could walk away from this line of business without any material impact to their profitability. The interest that would be foregone from divestiture would make little or no difference to a group of banks that together have trillions in assets on their balance sheets.

But if the banks do not want to divest, their regulator should make them do so.

The Office of the Comptroller of the Currency regulates nine of the ten largest banks lending in this space. The top five – Wells Fargo, Bank of America, JPMorgan Chase, Capital One, and Union Bank – all operate under the oversight of the OCC. The agency’s recent rulemaking on the deposit advance products marketed by several of its banks shows a concern regarding these high-cost products and the impact they make upon consumers of regulated institutions. But the OCC should also recognize that lending by national banks to these companies is a pressing problem. These practices pose a serious risk to the reputations of the banks under its supervision.

Adam Rust is the director of research at Reinvestment Partners, an advocacy group in Durham, N.C., and author of the blog  BankTalk


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