CFPB Regulation on Small-Dollar Lending: Creating a Healthier Lending Environment or Breaking-up a $46billion Industry?
In June 2016, the CFPB proposed a new set of regulations on payday, vehicle title, and certain high-cost installment loans. While the proposed regulations are designed to protect the interests and welfare of the consumer, many small-dollar lending insiders are arguing that the new rules will crush the currently booming $46billion industry. In order to properly discuss the implications of these regulations, it is important to examine what the new rules propose.
The New CFPB Rules Summarized:
The primary tenet of the new CFPB regulations will require lenders to correctly determine if a borrower will be able to repay the debt (without taking out another loan) before the loan is even issued. Although that may seem like a simple stipulation, the regulations would involve much more work than lenders have ever needed to do in order to determine a borrower’s ability to repay. Whereas in the past, lenders may have just ran simple credit check or asked for proof of income before issuing a loan, the new CFPB rule would require lenders to examine the borrower’s balance sheet and ensure that the individual would be able to afford loan payments on top of monthly bills and living costs.
The CFPB proposed rules go into great detail and length to explain specific requirements that must be met in order to determine ability to repay, as well as set rules for lenders on how they can obtain repayment even if they have direct access to the borrower’s bank account and how quickly/often lenders can issue loans to consumers that want to re-borrow. It is already apparent to both the CFPB and alternative lenders that these new regulations will significantly decrease the number of loans that can be issued each year. While it certainly is creating a more responsible lending atmosphere here in America, these new rules will undoubtedly have a negative effect on the currently thriving small-dollar/short-term loan industry.
Proposed Rule Could Eliminate 80% of Revenue: “Designed to Kill the Industry.”
Justin Hosie, a partner at Hudson Cook, LLP, focuses his practice on regulatory compliance for alternative lending. Hosie claims that statistical analysis shows that the new CFPB rule will eliminate 80% of the small-dollar loan revenue (which is close to $9billion according to a CFPB report from 2015) and is “designed to kill the industry.” Hosie believes that lenders will be forced to make “nonsensical” calculations in order to determine a borrower’s ability to repay. He argues that the phrase “ability to repay” used to refer to just repaying a loan, but the CFPB has changed and extended the definition so that “ability to repay” means “ability to repay after all the other expenses have been paid first.” Many would argue that this evolved definition makes for a much healthier and responsible financial environment, it will certainly decrease the number of loans that can be issued, and thus negatively affect the revenue of the industry.
The reach of the CFPB extends “far beyond what everyone was expected,” says Hosie. These new rules would not only affect payday and vehicle title, but also a large number of other “covered” loans. “If [an] organization is not a financial service provider under a given law they can be subject to CFPB,” said Hosie. Any merchant that is collecting an automatic payment from the consumer’s account and/or ran a credit report (ie. mobile phone or cable provider) is in the CFPB jurisdiction. While the proposed rules do not necessarily affect all non-traditional financial service providers at the moment, there is a distinct possibility that multiple industries could soon be affected by the standards set by the CFPB.
Are Consumers Being Protected Or Denied Loans When They Need Them the Most?
While most of the focus is on how lenders and the industry will be affected by these new rules, it is important to examine how the consumer will be affected as well. According to a 2015 CFPB report, approximately “12 million American households take small-dollar loans each year.” Under the proposed rules millions of those households would no longer qualify for those small-dollar loans. The CFPB advertises itself as a government agency with the chief aim “to make consumer financial markets work for consumers, responsible providers, and the economy as a whole.” The new rules are creating a safer, more financially responsible economy, but it can be argued that at first glance they seem to do more harm than good for the average consumer in need of a short-term/small-dollar loan.
Hosie explains that under the CFPB rules, “you can’t give emergency credit to someone whose balance sheet is not working. But that is when they need it.” Most consumers that are applying for small-dollar loans are living paycheck to paycheck, and often do not have many options when it comes to making ends meet. Unfortunately, in the past, alternative lenders have taken advantage of these consumers’ financial desperation. Although in the short run the new regulations seem to be denying consumers loans when they need them the most, in the long run, they are meant to protect consumers from “abusive and unfair” practices of lenders. It will be up to the lenders to adjust their practices to conform to the new regulations while also trying to maintain profitability.
How Will Lenders Cope and Comply?
Hosie says that the first reaction to the new rule is to fight it. Companies are writing letters to the Bureau and asking consumers to write letters on their behalf as well. He claims that they are preparing to challenge the rulemaking process in court. But besides fighting, there is one other thing lenders can do: innovate. Whether that innovation is in finding possible loopholes in rules or finding ways to comply with the rules. Moving forward, it may prove useful to examine how lenders have dealt with similar rules that were enacted in the UK in 2014. One thing is for certain; technology and innovation will certainly have a role to play.