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As Wal-Mart Stores Inc. (NYSE: WMT) showed us this week, consumer credit is finally expanding in the United States.
The retailer broke into the banking industry after years of opposition from banks and labor unions. Bloomberg reports that Wal-Mart is now backing Progress Financial.
Progress Financial is one of an increasing number of lending institutions that provides service to people without bank accounts or with bad credit history; primarily, it targets the approximately 23 million U.S. Hispanics who are characteristically unable to borrow due to their limited credit histories.
"Progress fills an important niche," Brian Melzer, an assistant professor of finance at Northwestern University's Kellogg School of Management, told Bloomberg. "They take people who banks won't take risks on…These people are getting access to credit. A certain amount of that is going to be spent at Wal-Mart."
Supporters of the deal say Progress Financial and other institutions like it are a needed alternative to payday lenders' triple-digit rates.
The move is also encouraging for U.S. economic growth. Around 75% of U.S. gross domestic product (GDP) is fueled by consumer spending.
Money Morning Capital Wave Strategist Shah Gilani isn't surprised one bit by Wal-Mart's play:
- "Wal-Mart has been trying to get a banking license for some time. Supplying financing to their customers makes perfect sense for a retailer, and this type of move isn't uncommon. For instance, look at the auto industry. It created financing arms for two reasons: to provide financing to the dealers, and to shoehorn customers into their own financing arms for profit."
Critics of Wal-Mart's ties with Progress Financial raise concerns about allowing consumers to stretch themselves too thin for "unnecessary items" like big-screen TVs.
Gilani takes an even-keeled approach: "Does it make sense that Wal-Mart did this? Yes. Should it create uproar? No, so long as everything is done by the books…"
Gilani: Consumer Credit Must Be "Done Right"
About the last thing we want right now is another financial crisis, and so expanding opportunities in the consumer credit industry must be done with extreme caution. Providing credit without taking risk into account, or with no limitations, is a recipe for a problem.
"Consumer credit is essential for our economic growth, but it can't be slathered on the people who aren't able to support their debt payments," Gilani differentiates. "It'd be a mistake to further consumer credit to the folks that are stretched.
"If imprudent people are provided with imprudent strategies, they're going to be…well, imprudent," Gilani says matter-of-factly.
In Wal-Mart's case, you'd have to ask how far it's going to go to let customers borrow. And what happens when a customer defaults?
"Wal-Mart won't take the product back from the customers, so what will it do? What is the delinquency rate relative to bottom-line earnings?" Gilani asks. "It's a slippery slope, and Wal-Mart should implement safeguards. It's not for them to judge, but it's a concern."
The same line of reasoning needs to be applied to all of these new opportunities for consumer credit, especially in burgeoning niches for providing credit to people with zero-to-little credit history.
What's the investor takeaway from all of this? Interestingly, the expanding market for niche consumer credit institutions, like Progress Financial, underscores a huge opportunity right now…