Short Term Loan Lenders Fear Impact of Pending Regulations
When the Consumer Financial Protection Bureau issued its first draft of the new regulations proposed for short term loan lenders in 2015, there was an immediate outcry. Payday lenders and others making short term loans claimed that the restrictive rules would either force them out of business or leave them with no choice other than to stop offering these loans. Although the CFPB solicited comments from the public as well as lenders, the final proposal issued in 2016 was virtually unchanged. Remarkably, however, the finalized rules issued in October 2017 have been scaled down significantly and will not go into effect until 2019. Despite the revisions, short term loan lenders are still holding their breath over the new regulations.
Why the New Regulations Have Short Term Loan Lenders Waiting to Exhale
The most onerous rule proposed — and the one that lenders claim would make short term credit too costly to provide — required lenders to determine the borrower’s ability to repay the loan. The CFPB proposal covered a variety of short term loans, including payday loans and certain installment loans. The final version made some slight adjustment to this requirement, but in essence, most lenders must still review a borrower’s income, debts and living expenses before approving a loan. Interestingly, the revised rules allow lenders to skip the test for a borrower’s ability to repay for certain loans, including some of the short term, small-dollar loans made by many credit unions and community banks — and within hours, the Office of the Comptroller of the Currency rescinded its 2013 guidance strongly encouraging banks to stop offering deposit advance loans that were similar to payday loans.
As you might expect, lenders providing short term credit products are not yet conceding defeat. For one thing, President Trump has repeatedly stated his antipathy for the Dodd-Frank Act, the far-reaching law that authorized the creation of the CFPB. Trump has also expressed his desire to see financial restrictions relaxed to make it easier for individuals and businesses to secure loans. Another ray of hope for lenders could be the departure of Richard Cordray, the current director of the CFPB. In July 2018, Cordray’s term will expire, but there are rumors that he may step down sooner to run for the office of governor in Ohio.
Jeremy T. Rosenblum, an attorney with Ballard Spahr LLP, made some interesting observations in an article posted at ConsumerFinanceMonitor.com. He states that the new rules may never go into effect; when Cordray leaves, the new director may not share his passion for crushing short term loan lenders or may feel that other issues are of greater importance. Rosenblum also states that the CFPB has never built a strong case proving that any associated harm to consumers outweighs the benefits of access to these types of small-dollar loans; he expects there will be litigation and that the short term loan lenders stand a good chance of winning.
As an independent agency, the CFPB can pass regulations without any additional approval. However, under the Congressional Review Act, regulations can be overturned within 60 days with a simple majority in both houses of Congress and the president’s approval. Should Congress decide to overturn the new CFPB regulations, it is extremely unlikely that Trump would veto the move. By May 2017, 14 rules issued by the former administration had been overturned by using the CRA, so it appears that Trump and his fellow Republicans are not averse to the tactic. Previously, the CRA had only been used successfully once; four attempts failed to pass both houses, while Obama vetoed all five resolutions submitted to him.
With so much uncertainty, it is little wonder that lenders offering short-term credit products are not willing to relax just yet. If the regulations go into effect, the payday loan as it currently exists could become extinct. Industry estimates predict that 80 percent or more of the payday loan stores operating today could go out of business; even the CFPB acknowledges that the impact will be severe, but the agency believes that “only” about half of the lenders will close.
Lenders providing short-term credit products are also still struggling to determine how the information system required by the new rules will work. The new regulations require lenders to deny loans to borrowers who have had a covered loan in the preceding 30 days, has an outstanding covered loan or has had at least six loans or has been in debt for at least 90 days during the previous year. Obviously, lenders will need access to a database that tracks short term loans to ensure that they comply with the law. The CFPB has stated that a minimum of one such system will be available by the rule’s effective date, but if there is not, lenders cannot make loans under the option that allows three consecutive loans to the same borrower as long as each loan is for one-third less than the previous. It appears that consumer reporting agencies will be the registered information systems required by the CFPB — and after the Equifax breach, this has many consumers feeling a bit uneasy.
The CFPB Regulations Hurt Lenders, But the Rules Could Have Been More Harmful
As bad as the new regulations are, things could have been much worse for short term loan lenders. Originally, the rules forced lenders to apply the ability-to-repay requirements to longer-term loans, including installment loans, that had an APR of more than 36 percent. The CFPB removed that requirement from its final rules. Considering that the Dodd-Frank Act explicitly states that the CFPB has no power to set interest rates or determine when a rate is usurious, this was probably a wise move on the agency’s part — litigation might have proved that the provision was effectively an attempt to define usury. However, it should be noted that installment loans requiring a balloon payment are still subject to the new regulations, and high-interest loans having terms of at least 45 days can be subject to the new regulations if the borrower allows the lender to initiate transfers from his or her account.
The Impact of New CFPB Regulations on Short Term Credit
Until the new regulations are in effect, it is difficult to predict whether a successful attempt to overturn them will be launched. However, many payday lenders have already started to gravitate to other forms of short term loans. Unsecured personal installment loans have become increasingly popular, especially for lenders who offer loans for people with bad credit.
Alternative lenders may also face increased competition from credit unions and banks. The CFPB final rules basically exempted these traditional lenders from some of the devastating regulations, and the move by the OCC to allow banks to again offer deposit advances may spur many bankers to look for new ways to make these small loans profitable.
It is highly likely that the short term credit industry will survive. Lenders will create new products and find new ways to adapt their business models to comply with the law. However, one fact is inescapable — the industry will be forever changed.