While the U.S. economy continues struggling to show signs of life, U.S. and international banks are tightening the noose on consumer lending, spurring the growth of payday loans. Prognosis for an economic turnaround early this year rapidly turned to fantasy as the January 2009 quarterly Federal Reserve Board Bank Survey showed bank consumer lending practices were squeezed even further. Times of economic pressure certainly prove that banks are among the first to act. Any small banking industry ripple of policy change can cause a tidal wave in the financial community.

53 U.S. banks and 23 U.S. branch offices of foreign banks responded to the Reserve Board in their study which concluded that the bank industry standards have further reduced consumer credit limit, increased interest rate floors and consumer credit review for short term loans. The banking crunch has inevitably led to the phenomenal growth of a second tiered loan sector including cash advances and payday loans, which are less stringent on their approval standards on unsecured personal consumer loans.

Domestic & International Banks Further Reduce Credit Limits

Between 45-60% of bank survey respondents reported raising credit score thresholds in order to approve consumer loans or new credit card applicants. As the credit score threshold increases, more of the general population requiring a short term loan falls below the new cutoff point. More banks indicated that they reduced the number of installment and short term loans approved for consumers who did not meet the increased requirements. In essence, banks want to provide short term consumer loans for their select few. Banks are pulling through this recession economy by not taking any chances with ordinary consumers. Joe Average definitely needs to seek out his money elsewhere.

Bank Policies Raise Interest Rate Floors & Decrease Equity Loans

With the mortgage financial crisis looming in the near past, equity loans have floundered, dropping a near 70%. Consumers who in the last couple of years could have used the equity in their homes must now be subject to similar stricter guidelines comparable to consumers lacking homes and means to borrow an installment loan. Interest rate floors have increased across the banking industry, leaving critics of payday loans and cash advances with little to say.

Bank Consumer Loan Requirements Tedious

Convenience and timing in obtaining a consumer loan even if credit requirements are met are also a limiting factor in processing bank installment loans. The average processing time for a bank to approve an unsecured personal loan is 5-7 business days from the date of application. Requirements on consumer loans typically call for a credit rating of 650+ while a whopping percentage of the national population may fall under that score.

Banks also typically require the presence of the borrower to sign for the application as opposed to cash advance and payday loan options, where borrowers are able to electronically sign documents and find out readily if they are able to qualify for the loan. The slow timing process of bank loan application documents also account for consumers withdrawing their application requests and acts as an additional factor weeding out a segment of installment loans. If consumers are applying in an emergency situation to obtain money needed in a couple of days, bank loans would be almost out of the question.

Phenomenal Growth of Second Tiered Loan Sector

Since the 1990s the second tiered consumer loan system including cash advances and payday loans have phenomenally flourished. Consumers holding jobs could obtain money readily even while they lacked the credit necessary to obtain an equivalent loan amount from traditional banks. The traditional banking sector has criticized cash advance and payday loan lenders for charging excessively high interest however, traditional banks have exhibited the same characteristics through traditionally “justifiable” non-sufficient fund fees charged at a typical rate of $25 per transaction.

If the interest on a payday loan were $50 as compared with 6 transactions from the bank charged at $25 per incident (total $150), which company would be charging excessively high fees? Traditional banks have existed much longer than the relatively new second tiered sector but the cash advance sector offers different levels of convenience, flexibility, options and speed in their loan approval process. After all, the creation and growth of cash advances and payday loans fulfill a need that is currently not being met by the traditional banking industry.