The value of small-dollar loans

Three community banks explain why making responsible small-dollar loans benefits not only their customers but also the banks themselves.

By Katie Kuehner-Hebert

Most community banks that make small-dollar loans to customers may not make a lot of money—but they still can gain a lot in return.

The FDIC’s pilot program was a case study “designed to illustrate how banks can profitably offer affordable small-dollar loans as an alternative to high-cost credit products such as payday loans and fee-based overdraft programs,” the agency writes.

Overall, small-dollar loan default rates were in line with default rates for similar types of unsecured loans, according to the FDIC.

“A key lesson learned was that most pilot bankers use small-dollar loan products as a cornerstone for building or retaining long-term banking relationships,” it says. Here are three community banks that have experienced the benefits of small-dollar loans.

Kentucky Bank
The $1 billion-asset Kentucky Bank in Paris, Ky., one of the FDIC program participants, makes small-dollar loans to meet the credit needs of the low- to moderate-income individuals in its communities while practicing safe and sound operations, says Brenda Bragonier, senior vice president and director of marketing.

“This program allows Kentucky Bank to serve the needs of customers who wish to borrow a small amount of money in a very efficient manner, such as funds needed for a car repair,” Bragonier says.

Currently, the community bank has 65 small-dollar loans on the books, with loan amounts ranging from $500 to $2,499. More than half of the loans made are for less than $1,000. Kentucky Bank’s underwriting standards for the loans are derived from the FDIC’s recommendations, including allowing a FICO minimum score of 195 to qualify. The terms range from 90 days to 36 months, depending on the loan amount, and only one small-dollar loan is allowed at a time per customer within 30 days.


Benton State Bank’s
average small-dollar
loan amount

“The SDL [small-dollar loan] is unsecured, and it does not have an application fee or a prepayment penalty,” says Sherry Belleville, Kentucky Bank’s client relationship advisor. “It can be a perfect solution for a customer that needs a small amount of cash.”

Benton State Bank
Kay Brink, senior vice president at the $65 million-asset Benton State Bank in Benton, Wis., says her bank’s average small-dollar loan amount is $1,000, but it has granted a loan for as little as $100. Benton State Bank serves a primarily agricultural area, with many small communities situated in the lowest-income county in the state. “So smaller loans are needed,” Brink says.

“For the bank, it does generate some income, but it’s more of a community service,” she says. “The bank is here to help people at whatever income level they are at, if we are able to, and it also helps increase customer loyalty.”

Benton State Bank makes these loans on a case-by-case basis, reviewing each application individually, Brink says. While it uses the same underwriting procedures as it does for all consumer loans, since they are in a small rural area of the state, they get to know their customers very well. Benton State Bank prides itself on “creative financing,” and their customers know that.

“Customers appreciate that the bank is willing to work with them when others may not,” she says.

Red River Bank
F. Jannease Seastrunk, vice president and community relations/Community Reinvestment Act officer at the $1.7 billion-asset Red River Bank in Alexandria, La., says that the bank not only considers the small-dollar loan needs of the unbanked and underbanked but also the needs of young consumers.

“They’ve witnessed this current financial crisis and may feel very differently about acquiring debt, and we anticipate they will prefer short-term, small-dollar lending,” Seastrunk says.

Many small-dollar loan customers also return to Red River for their larger needs later on. “We don’t just want one-time customers; we want customers for life,” Seastrunk says.

For those who have relied on payday lenders in the past, Red River provides resources to help them access traditional banking through such programs as Red River Bank University, which offers in-person and online financial education to community members. The community bank also regularly sponsors financial education events and provides speakers and trainers for local nonprofits, schools and churches.

“We believe that we have a wealth of knowledge within our bank and we want to share that with our current and potential customers,” Seastrunk says. “We’ve trained more than 40 employees to be prepared to offer financial education around the state on topics ranging from preparing for homeownership to understanding and repairing credit to investing for the future.”

The future of small-dollar loans
In October, the Consumer Financial Protection Bureau issued a final rule on small-dollar loans intended to curb abusive practices by payday lenders. However, the rule exempts lenders that make 2,500 or fewer covered short-term or balloon-payment small-dollar loans per year, and that derive no more than 10 percent of their revenue from such loans. “ICBA appreciates that the bureau’s rule recognizes community banks as responsible lenders that do not engage in abusive lending practices, and work with their customers to establish favorable loan terms that reflect their customers’ financial history and ability to repay,” ICBA president and CEO Camden R. Fine said at the time. “This exemption will enable community banks the flexibility to continue providing safe and sustainable small-dollar loans to the customers who need it most.”

Jeffrey C. Gerrish, founding director of Gerrish Smith Tuck Consultants and Attorneys PC in Memphis, Tenn., says many community banks that focus on commercial lending will offer small-dollar loans to employees of their business-owner customers as a gesture of goodwill.
“It’s good for the bank’s relationships with business customers to accommodate them by taking care of the needs of individuals who work for that company,” Gerrish says.

For banks that offer this as a product line to all customers, it’s imperative to have someone with expertise overseeing the program, he says. The key is to be efficient in the underwriting process.

“Community banks need to serve their communities, and making small-dollar loans to people who otherwise can’t get credit makes a lot of sense—as long as banks don’t lose money,” Gerrish says. “It’s a good thing to do.”

One option for community banks over the coming years will be to partner with fintech companies making white-label small-dollar loans on behalf of banks, says Joseph H. Cady, managing partner at CS Consulting Group in Lake Arrowhead, Calif.

However, community banks that implement machine learning in their underwriting processes might choose to keep small-dollar loan production in-house, because the greatly enhanced system could improve profitability, target marketing and underwriting, Cady says.

“With machine learning, you feed into your system an algorithm showing the 20-year history of what a good loan looks like, and the system starts looking for patterns,” he says. “It continues to learn the more and more you feed into it, and so these types of loans get faster, easier, more accurate, [more] profitable and more safe to produce.”

Katie Kuehner-Hebert is a writer in California.