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By Jeff Bater
June 2 — The Consumer Financial Protection Bureau's long-awaited regulatory plan cracking down on payday lending falls short of guiding banks to step up and offer an alternative product that will fill a strong demand in the U.S. for small-dollar loans, experts say.
“There is nothing in this rule that would let banks make affordable small loans at scale. Consequently, the CFPB is missing a major opportunity to save millions of borrowers billions of dollars,” Nick Bourke, an expert on small-dollar lending for the Pew Charitable Trusts, said in an e-mail to Bloomberg BNA.
The CFPB's proposed rule is meant to help strapped borrowers stay out of a cycle of debt and endless fees by requiring payday lenders to determine their ability to repay and placing restrictions on repeat loans. The proposal covers short-term credit such as payday loans, as well as high-cost installment loans.
Banks have been hesitant to enter the small-dollar market due to regulatory compliance concerns. In 2013, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency put out guidance that, while not handing banks a prohibition, nonetheless warned institutions of the risks of short-term, small-dollar loans (105 BBD, 6/1/16).
The CFPB's proposed rule does nothing to encourage banks to re-enter the market “and much to discourage them from doing so,” Reed Smith Partner Robert M. Jaworski said in a June 2 e-mail to Bloomberg BNA.
“The ‘full payment' a/k/a ability-to-repay requirement would appear to be a non-starter for banks. And, while banks might be able to overcome the somewhat more manageable hurdles presented by the ‘principal payoff option,' it seems likely they would decide the risks outweigh the potential rewards,” he said.
The bureau's proposal covers payday loans, auto title loans, deposit advance products, and certain high-cost installment and open-end loans. Among the protections in the rule is a “full-payment test” that would require lenders to assess whether the borrower can afford the full amount of each payment when it’s due.
The rule also includes a “principal payoff option” for certain short-term loans and two less risky longer-term lending options so that borrowers who may not meet the full-payment test can access credit without getting trapped in debt.
For short-term loans, such as payday loans and single-payment auto title loans, lenders would have to determine that borrowers have sufficient income to pay loans and meet their obligations during the term of the loan and for 30 days after paying off the loan or paying the loan's highest payment.
Under the proposal, consumers could borrow a short-term loan up to $500 without the full-payment test as part of the principal payoff option that is directly structured to keep consumers from being trapped in debt. Lenders would be barred from offering that option to consumers who have outstanding short-term or balloon-payment loans or have been in debt on short-term loans more than 90 days in a rolling 12-month period. Lenders would also be barred from taking an auto title as collateral. As part of the principal payoff option, a lender could offer a borrower up to two extensions of the loan, but only if the borrower pays off at least one-third of the principal with each extension.
During development of the rule, the CFPB had considered an option that would allow lenders to make a longer-term loan under the condition that the amount the consumer is required to pay each month is no more than 5 percent of gross monthly income. It was dropped from the proposed rule.
Some of the largest banks were apparently willing to develop a loan program based on the CFPB’s inclusion of that requirement, Jaworski told Bloomberg BNA. “Unfortunately, the CFPB chose to exclude that provision from its proposal,” he said.
The new plan would allow lenders to offer two longer-term loan options with more flexible underwriting. The first option would be offering loans that generally meet the parameters of the National Credit Union Administration “payday alternative loans” program, where interest rates are capped at 28 percent and the application fee is no more than $20. The second option would be offering loans that are payable in roughly equal payments with terms not to exceed two years and with an all-in cost of 36 percent or less, not including a reasonable origination fee, as long as the lender’s projected default rate on those loans is 5 percent or less.
“I expect neither of these alternatives will appear very attractive to banks,” Jaworski said. “First, while it’s possible credit unions, which are not subject to taxation, may be able to profitably make ‘payday alternative loans,' that does not mean that banks can. Second, the 36% ‘all-in' alternative subjects banks to a potential ‘double-whammy' if their default rate on these loans exceeds the 5% trigger in any year — they would have to return all origination fees they collected from these borrowers and suffer the losses resulting from the defaults.”
Richard Hunt, president of the Consumer Bankers Association, said the CFPB plan effectively forces most banks “to stay on the sidelines” of the small-dollar market due to greater compliance burdens.
“The CFPB has indicated it would like to see banks provide small-dollar loans to consumers in need, like the nearly half of the country who cannot afford a $400 emergency expense,” Hunt said in a statement. “Consumers across the country will now turn to pawnshops, offshore lending, and fly-by-night entities that will be more costly to them.”
The need for temporary credit was made evident in May with the release by the Federal Reserve of a study on the economic well-being of U.S. families that found 46 percent of adults either could not cover an emergency expense costing $400 — or would cover it by selling something or borrowing money.
Approximately 12 million Americans take out payday loans, spending $9 billion on loan fees, Bourke said in a news release following the CFPB's June 2 proposal. An additional 2.5 million take out auto title loans annually at a cost of $3 billion.
“Payday loan reform is urgently needed, but without changes, the CFPB’s draft regulation misses the mark,” Bourke said in the new release. “Pew’s research shows that borrowers want three things: lower prices, manageable installment payments, and quick loan approval. The CFPB proposal goes 0 for 3.”
The CFPB rule could cause “significant consolidation” in the payday lending space, according to a note by Isaac Boltansky, an analyst at Compass Point Trading & Research.
Comments on the rule are due Sept. 14. Boltansky, weighing in on a possible timetable going forward, said that on an assumption it will take the CFPB nine months to turn the comments, a final rule could be released in June 2017 — and that it would be in effect by September 2018.
In addition to the proposal released June 2, the CFPB also kicked off an inquiry into other potentially high-risk loan products and practices that are not specifically covered by the rule. Boltansky said the tone of the request for information (RFI) “is noticeably more aggressive than a typical release of this type.”
“Our sense is that the CFPB released this RFI in order to both better inform its forthcoming installment lending larger participant rulemaking and to discourage payday product migration,” he said. “We continue to believe that traditional installment lenders are positioned to benefit from the regulatory headwinds facing the payday industry as volume slowly shifts but this release adds a new headline risk for the space.”
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