Reading the Consumer Financial Protection Bureau’s proposed rules for regulating payday loans, I couldn't help but recall the late Yogi Berra’s line, “It’s like déjà vu all over again,” alongside the Hippocratic Oath (“First, do no harm”).
Two years ago, the Office of the Comptroller of the Currency issued rules governing non-collateralized, “advance deposit” loans – a bank product that bore considerable resemblance to nonbank payday loans. Within days of the OCC’s promulgating its rules, every significant bank that offered the product decided to pull it from the market.
The OCC’s 2013 rules imposed strict new underwriting requirements to ensure that the borrower had the ability to repay. The rules limited borrowers to one loan per month, to be repaid within 30 days; imposed a one-month cooling off period between loans; and required a six-month review to determine if the financial situation of the borrower had improved.
The combination of these rules almost guaranteed the product wouldn’t solve most borrowers’ credit needs, and thus wouldn’t generate enough volume to justify the cost to lenders.
Unfortunately, I can’t help but fear an even worse outcome from the CFPB’s proposals: Strict new rules for underwriting; a 60-day cooling-off period between loans; a requirement that no further loan can be made for an entire year unless the borrower can prove his or her financial situation has improved; and a 90-day limit for all such loans in any year.
These limitations, if implemented, all conspire to the same end. Since most borrowers can’t solve their problems in a month, they won’t want this product – and, if they could qualify, they likely wouldn’t need it. Indeed, the CFPB’s own data suggest that revenue for a typical payday lender would drop 60% to 75% under the proposal.
Just as with the OCC, the CFPB will be writing regulations that solve neither the credit needs of legitimate borrowers nor the profit needs of legitimate lenders. Even lenders that follow the strict payday rules in states such as Colorado, Florida, and Oregon would not meet the new standards. These lenders, already finding their margins quite low, will see their volumes collapse and will have no choice but to exit the field.
No doubt some people would be delighted by the elimination of small dollar non-collateralized loans. This time, however, unlike following the OCC action, there will be few, if any, regulated institutions left to fill the void. This will leave loan sharks and offshore, unregulated lenders.
CFPB Director Richard Cordray has on many occasions stated that millions of borrowers need small dollar loans and that most of them do not have relatives who can or would bail them out in times of need. Assuming he is sincere in his views, which I do, this suggests it is time for the CFPB to go back to the drawing board.
Director Cordray is right that millions of lower income borrowers need and should have access to properly regulated and transparent loans. He is also correct that no lender should make loans to individuals the lender knows will not repay. These simple truths represent a sensible place for the CFPB to begin in its quest to bring necessary reforms to small dollar lending.
The CFPB should honor and respect our time-honored federalist system of financial regulation. Some states and sovereign tribes do not allow payday lending. That is their prerogative. Most such jurisdictions allow and regulate payday lending. But many people believe regulation could and should, in at least some cases, be more protective of consumers.
It’s clear that millions of people need relatively quick and easy access to small-dollar credit. While they are typically able to repay this credit in a month or two, in some cases they can’t, despite their best intentions. Responsible lenders do not allow these loans to be rolled over more than a few times, at which point the customer has an option to convert the loan into a few installments (interest free) to pay it off. There is no good reason this approach should not be codified in law or regulation.
The CFPB could do enormous harm to millions of consumers by continuing on its current track, which will almost certainly shut down regulated short-term lending. Alternatively, the CFPB has the opportunity to learn the lessons from others' mistakes and put forward thoughtful reforms that not only do no harm, but instead improve the lives of millions of middle and lower income borrowers for whom payday loans are a much-needed, cost-effective lifeline.
William Isaac, a former chairman of the Federal Deposit Insurance Corp.,
is senior managing director and global head of financial institutions at FTI Consulting.
He and his firm provide services to many clients, including some who may have an
interest in the subject matter of this article. The views expressed are his own