Last week, the Consumer Finance Protection Bureau (“CFPB”) released its much anticipated regulatory proposal to regulate payday loans, auto titles and certain high cost installment loans (“covered loans”). The stated purpose of rule-making is to protect paycheck-to-paycheck-to-paycheck consumers from the so-called “debt spiral” of serial borrowing and multiple loan origination fees and overdraft caused by chronic liquidity needs. Since the proposed rule covers 1334 densely packed pages, it will take some time to digest the general requirements and the potential impact. So far, however, opinions on the likelihood that the proposed regulation will meet its stated objectives and the impact it might have on particular businesses or borrowers appear to depend on perspective. For some, the proposed rule is an example of CFPB overshoot which threatens their business and “really misses the point.”[es] the brand, ”as Richard Hunt, president and CEO of the Consumer Bankers Association, noted last week. For others, the development of rules would seem to have a marginal impact, if not nonexistent. And some FinTech companies see the proposed rule as an opportunity for market disruption and new entrants.
Summary of the rules proposed by the CFPB for payday loans
The CFPB proposal would impose a series of regulations on two categories of loans: (1) those with a term of 45 days or less and (2) those with a term of over 45 days provided that: (i) they have a total cost of credit duration greater than 36% and (ii) are either reimbursed directly from the borrower’s bank accounts or income, or guaranteed by the borrower’s vehicle. (See Rule proposed in § 1041.3.)
For both categories of secured loans, the proposed rule:
- require lenders to reasonably determine that the borrower has the ability to repay the loan (with the exceptions discussed below) (Rule proposed in §§ 1041.5 and 1041.9);
- limit the ability of a lender to collect secured loans via a direct withdrawal from a borrower’s bank accounts (rule proposed in §§ 1041.14 and 1041.15); and
- require lenders to provide information about origination practices to registered information systems (rule proposed in §§ 1041.16 and 1041.17).
For secured loans with terms of less than 45 days, the proposed rule would allow a lender to waive a repayment capacity determination in very limited circumstances. In particular, a lender could, without determining the repayment capacity, grant a maximum of three consecutive loans to a borrower, the first loan having a principal not exceeding $ 500, the second loan having a principal of at least one third less. to the first, and the third loan having a principal amount at least two-thirds less than the first loan. (Rule proposed in 1041.7 (b) (1).) The proposed rule, however, precludes the use of this exemption if the granting of the loan would result in the consumer having more than six short-term loans covered over the course of for a period of 12 consecutive months. or be in debt for more than 90 days on short-term covered loans for a period of 12 consecutive months. (Rule proposed in 1041.7 (c) (4).)
The proposed rule offers a slightly different option to avoid a determination of repayment capacity for loans with a term of more than 45 days. For longer-term covered credit, a lender can avoid a repayment capacity determination in two different scenarios. First, the lender could offer borrowers the same protections typically offered under the National Credit Union Administration for “alternative payday loans” and apply a 28% interest rate cap on loans and application fees. not exceeding $ 20. (“PAL Approach”). (Rule proposed in § 1041.11) Alternatively, the lender could make a longer term loan, provided that the amount the consumer is required to repay each month does not exceed 5% of the consumer’s gross monthly income and the lender does not make no more than two of these loans in a 12-month period (“Portfolio Approach”). (Rule proposed in § 1041.12)
Failure by a lender to comply with any of the above requirements would be considered an abusive and unfair practice subject to CFPB enforcement action.
Potential impact on current providers of short-term consumer loans
The most significant impact of the proposed regulation on current payday lenders appears to be the limits it would place on the frequency of short and long-term loans as well as the proposed caps on certain origination fees. The Community Financial Services Association of America, a trade group in the payday lending industry, released a statement last week saying that “by the [CFPB’s] Own estimates, this rule will wipe out 84 percent of lending volume, creating financial havoc in communities across the country. minus a reduced loan volume.
Second, even if the proposed regulations do not significantly reduce the volume of loans, the requirements to determine a borrower’s repayment capacity will likely increase origination costs for payday lenders who do not currently use underwriting practices. traditional. For these lenders, increased costs, paperwork and procedures could fundamentally change their business model and / or profitability. For lenders who currently use traditional underwriting practices, the impact of this part of the proposed regulation would appear to be much less. Currently, the proposed requirements imposed to determine ability to pay include:
- verify the borrower’s net income;
- verify the borrower’s debts using a credit report from a “registered information system”;
- check the borrower’s housing costs;
- provide a reasonable amount for the borrower’s basic living expenses;
- project the borrower’s net income, debts and housing costs for the period covered by the loan; and
- project the borrower’s ability to repay the loan based on the projections above.
(Rule proposed in § 1041.5). All of the above are fairly standard aspects of a traditional loan underwriting process.
A final important impact of the proposed regulation on lenders is the restriction on loan collection methods. For all short- and long-term covered loans, the rule would subject a lender to the following collection restrictions:
- Typically, a lender should give the consumer at least three business days’ notice before attempting to collect payment through direct access to a consumer’s checking, savings, or prepaid account.
- If two consecutive attempts to withdraw money from a consumer’s account made through any channel are returned for insufficient funds, the lender will no longer be able to attempt to withdraw money from the account unless the consumer has provided a new authorization.
The extent to which these new regulations would reduce lending volume and / or increase costs for current payday lenders will undoubtedly be the subject of much debate during the comment period, with differing estimates based on assumptions. different.
Potential impact on established banking institutions and new market entrants
For some banks and credit unions, the biggest disappointment with the proposed regulation by the CFPB appears to be the removal of the so-called “pay-to-income test” that had been included in the previous outlines of the proposed rule published by the CFPB. . The pay-to-income test would have allowed lenders to issue loans, without making a determination of repayment capacity, as long as repayment was limited to 5% of the consumer’s income. At least a few banks and credit unions have reportedly designed products based on this exemption. The loss of exclusion can mean that these credit unions and banks forgo entering the consumption space in the short term because the costs of origination and collection are prohibitive.
Some online lenders and FinTech companies (market lenders), on the other hand, seem to believe that the proposed regulations will give them greater opportunities to fill the void left by traditional lenders. These new market entrants argue that providing cheaper borrowing options to consumers can be achieved profitably through the use of more and better technologies. For example, LendUp, a startup backed by Google Ventures, supports the proposed new rule. LendUp CEO and Co-Founder Sasha Orloff said, “As a mission-driven startup committed to redefining how underbanked consumers access financial services, LendUp shares CFPB’s goal of reforming the market. deeply troubled payday loans. LendUp, like others, apparently believes the proposed regulations may provide it and other FinTech companies with a competitive advantage based on its improved technology.
Market lenders generally lend for periods longer than 45 days; some lend at APRs above 36% and most lend without collateral. If these lenders do not require direct access to a borrower’s bank account or income, the CFPB rule, as proposed, would not apply. If direct repayment is required from the borrower’s bank account or income, the CFPB rule, as proposed, would apply. The question would then be whether the lender’s credit determination – its analysis of repayment capacity – is consistent with the analysis prescribed by the proposed rule (or with the limitation of 5% of gross monthly income / maximum of two loans per 12 months). If not, a comment letter and other advocacy may be appropriate as to why the market lender’s methodology is at least as sufficient to assess repayment capacity as the analysis prescribed by the proposed rule.
Potential impact on consumers
Perhaps the most interesting aspect of the regulation proposed by the CFPB has been the divergent views on the impact on consumers. Some consumer protection groups, such as the Consumer Federation of America, support the proposed regulation and believe it represents an attempt to protect borrowers. Other groups seem to believe that while this is a good start, it does not go far enough and leaves loopholes that need to be closed. While other consumer groups believe it goes too far and will lead to less liquidity options for the most underserved, leading them to loan sharks, pawn shops or other less desirable alternatives to meet the demand. their liquidity needs.
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In light of these competing interests and competing views, we expect a myriad of comments to be submitted by the end of the comment period on September 14, 2016.