True confessions of a Loan Shark

The speaker was passionate. “You bankers need to understand our culture is not like your culture!  In our community, we don’t expect bills to be paid on time.  If you are really interested in serving our community, you need to adjust your expectations and not be asking us to change our culture in order to qualify for your loans!”

Wow! Did I get an education a few years ago in my bank’s attempt to reach out to a minority community by holding educational meetings on how to access bank credit. We were prepared to discuss FICO scores and the importance of a good track record of paying bills on time.  Instead, we walked away thinking we may have done more damage than good as we learned of this community’s view of our industry that did not match our own noble view.

In our defense, our intentions to serve every segment of our community, including low income areas, were honorable. But we ran into a wide cultural divide we were ill equipped to handle.

But as a young community bank CEO, I was idealistic and not easily discouraged. I was intent on finding a way to reach out and serve everyone. We had purchased a Wealth Management company to serve our well-healed customers.  The bank itself was well equipped to serve the financial needs of the mass middle of our community. But I felt there must be a way to reach the un-banked. That desire, however noble, set me up for an embarrassing failure reaching out to our low-income neighbors.

The Short, Sorry Saga of Freedom Loans

Freedom Loans (pseudonym) sat in the middle of our Midwestern town and had a big ugly green sign in front of the store. That sign would come alive at night and blink its bright neon red lights spelling out the word, “LOANS…LOANS…LOANS.” It was cheesy at best. Hardly the image a preeminent bank in town would want to project.

The owner of Freedom Loans- I’ll call him Tex- wanted to sell the business. I thought, “Perfect! We’ll buy his company and this will be our way learning how to serve the un-banked in our community.” And boy, did I did learn a lot. Here are the highlights:

1. The poor do not pay on time and don’t care about late fees.  One of my first conversations with Tex was on his need to bring down his past due ratios.  My bank kept past dues below 1% and Freedom was around 20%. Tex just looked at me and shook his head saying, “You don’t understand what we do at all, do you? We love past due loans. That’s how we build up our late fee income.  And nobody ever complains.”  And as I found out, he was right.
2. The poor do not care what interest rate they pay. Freedom Loans averaged about 28% in interest on loans. The bank rates were a fraction of that usurious interest. Our bank customers cared and would comparison shop and negotiate furiously for a low rate. Tex taught me the poor don’t care about rate, only the amount of the monthly payment matters to them.
3. The poor will pay almost anything to maintain one reliable line of credit. Freedom Loans gave me a good education into the mind of the un-banked. They don’t care about interest rates.  They don’t care about late fees. They don’t care about any other debts they might have running past due. But they do care about keeping Tex happy because he is their emergency fund.  Tex would always advance them a new loan when needed if they would continue to work with him. You could say Freedom Loans was a friendly loan shark to the poor.
4. It’s hard to find good people to work in high interest loan shops .  Tex only wanted to stay on for a short transitional period while he trained someone to take his place. We hired a young man to train under Tex with the intention of making him the new president when Tex left. However, this trainee never seemed to buy into the lending philosophy Tex held. In the end, our trainee quit and went to work for a church where he found more compatible values.  I always wondered if it was his way of paying penance for his time at Freedom Loans.
5. The poor suffer from fear and shame. Freedom Loans had a hidden parking lot in the back that allowed customers to enter without being seen. Tex explained to me that this private rear entrance was a key to the Freedom’s business model. You see, the poor almost never enter a traditional bank lobby out of shame that they don’t belong there. But they also want to hide their poverty from others which would be revealed if they were seen entering a high interest loan shop. Freedom Loans made it easy for them to hide their shame by offering a private rear entrance. In many ways, it was similar to what a porn shop might construct to keep customers identity private.

In the end, my Freedom Loans experiment ended fairly quickly in failure. Our organizational values were incompatible with charging exorbitant interest and fees on the poorest among us. In fact, Freedom Loans never really made any money either. The lack of profitability was probably because no one in my bank could buy into the Freedom Loans philosophy.

But the failure motivated me to look elsewhere for ideas on how to help the poor. Over time I’ve found some answers that work much better than my poorly conceived idea to buy Freedom Loans.  

Helping the Poor move from Fear and Shame to Flourishing

Warren Buffett’s partner, Charlie Munger, has a saying, “invert, always invert.” In other words, turn a problem upside down and look at it backwards. Today’s blog is something of an inversion. Instead of speaking on ways to grow wealth, we’ve looked at some of the reasons why the poor stay poor. But I don’t want to leave it there. Here are a few ideas I’ve seen that are effective in raising the poor out of their mindset of poverty.

1. Investment Clubs.  Over time I was able to become friends with a number of pastors in the minority community where Freedom Loans operated.  I was excited to learn that they had formed an investment club that regularly met to pool their money and make investment decisions. These wise pastors knew that one path out of poverty was to teach their members to think like owners and less like debtors. And I think it was successful because the effort came from within the minority community.
2. Peer Micro Lending and Savings Groups Appear to be a Better Path.  Similar to investment clubs, another path to human flourishing for the poor has been documented in developing countries through the formation of savings groups.  Men and women who are given the chance and encouragement to accumulate capital in a safe place are successful in all kinds of cultures. These savings groups are growing all over the world as a way to encourage capital formation without the bureaucracy of bankers like me being involved. Members can then take loans from these savings groups, if approved by their peers, for purposes such as business expansion, home improvements, medical care or other needs without an exorbitant interest rate.  The beauty of savings groups is the way they encourage savings and wise credit based on their peer’s evaluations rather than a professional banker from another culture. Organizations like Hope International, or the Chalmers Institute, have seen success in implementation of these ideas in developing countries.  Similar principles could be done more effectively in the US than from traditional banking efforts.  
3. Religious and Philosophical Teaching Against Charging Interest to the Poor is still Applicable. There is a good reason for the biblical prohibition against moneylenders charging interest to the very poor. It has been condemned throughout history by religions and philosophers. The poor are the least able to afford high interest and it is a means of oppression. As far as I know, Freedom Loans didn’t help anyone in my town escape poverty. It most likely kept them poor.

My true confession of being a loan shark for a time may not have the same impact as the thirteen books St. Augustine wrote discussing his Confessions.  However, seeing the truth about high interest lending to the poor was an important lesson for this banker to learn. Not every market segment is a profitable niche, nor is it ethical to try and make a profit off of the poorest segment of our society among us.  But that does not mean we should quit looking for alternative ways to bring human flourishing to the least among us.

Joe Kesler

Founder

Smart Money with Purpose