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CFPB Should Tread Cautiously on Payday Loans

Readers of the American Banker know that I am very concerned that regulators at the Consumer Financial Protection Bureau might inadvertently strangle the small-dollar, payday loan market, destroying a lifeline of credit for millions of responsible, low- and middle-income Americans. CFPB Director Richard Cordray, whom I respect and believe wants sincerely to keep small-dollar credit available, would do well to have his staff talk with researchers at the Urban Institute.

The institute's recent study, "Small-Dollar Credit: Protecting Consumers and Fostering Innovation" (December 2015), is the latest in an intelligent series of published roundtable discussions about what researchers and regulators know — and do not know — about small-dollar credit. The authors of the study (Signe-Mary McKernan, Caroline Ratcliffe, and Caleb Quakenbush) point out that most research on small-dollar loans focuses on consumers' needs and behaviors, but is quite light, at best, on the needs and behaviors of lenders.

Yet, without a better understanding of providers' business models, profitability, loss rates, volume and overhead costs, regulators cannot possibly create a product that ensures consumers get the credit they need and deserve. The first protection a consumer needs is the assurance that any new reforms will not inadvertently drive all regulated credit from the market. No lenders, no credit. Or worse, as the authors note, consumers will be forced to find other, far more harmful products.

The authors note that most research suggests the overwhelming majority of borrowers need credit because of a family emergency; a temporary, unexpected cash shortfall; or an occasional manageable gap between paychecks. Right now most of these consumers are getting credit when they need it. Regulators must be careful that they do not destroy this supply of credit while trying to help the much smaller percentage of borrowers who probably should not be getting credit at all.

To this end, the authors offer some suggestions. First, technology changes "more rapidly than the law," so regulators should not freeze products or procedures in ways that might stifle more effective or efficient technologies coming onto the market. My own experience suggests that this is especially true as new technologies enhance our ability to do quick and accurate underwriting, but it also might apply to other innovative and safe products in the nonbank space.

Second, regulators should not ignore experience for the sake of an abstract ideal. The authors note that payday lenders do not operate in those states with a 36% APR cap, yet many people still advocate that reform. Similarly, almost no licensed lender makes advances to military families anymore due to imposition of the same 36% APR rule. We need to learn from what does and does not — and never will — work.

Third, in an environment in which knowledge is still quite limited, we should not try to do too much too quickly. The states have a long and successful history serving as the laboratories for innovation in bank products and services and regulation. Regulators should look especially at the experiences of states that have made successful changes. The authors note that Colorado's movement toward small installment loans is quite worthy of study. No doubt there are other states whose models also work well.

Lastly, the authors suggest that regulatory innovators experiment with "pilots" first and be careful to build proven "safe harbors" into their regulatory innovations so that providers will have confidence they are in compliance with the law. As the authors wisely note, reforms that inadvertently destroy lenders will seriously "disrupt the lives" of consumers without solving their need for credit.

As a former regulator, I know all too well the temptation to write the perfect rule based on personal preferences rather than hard data. And as a longtime observer of, and participant in, the financial industry, I have seen well-intentioned regulations destroy the nascent small-lender market in commercial banks.

The Urban Institute has done us all a favor by reminding us at the outset of its article that regulatory prudence beats regulatory hubris: "Financial regulations can help protect consumers from harmful practices, but their benefits must be weighed against their potential to drive potential innovators from the market, unnecessarily restrict consumers' access to credit, or, worse, push consumers toward other more harmful products."

I hope the CFPB staff will heed these words of caution while promulgating new rules on small-dollar lending.

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.


(9) Comments



Comments (9)

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Posted by Nordic | Wednesday, April 06 2016 at 1:04PM ET
Several studies show payday loans don’t have a negative effect on borrowers’ credit scores. Instead, research suggests these short-term loans help borrowers avoid bouncing checks (which can cost more than a payday loan) and help borrowers pay their bills. Roughly one in four American households conduct financial transactions outside the mainstream banking system. Without a checking account or savings account, they lack access to traditional loans and credit cards, among other things. When these
Posted by tommy0 | Wednesday, March 30 2016 at 7:39AM ET
Many of the people in US and Canada are depending on
Posted by maxandersonlv | Saturday, March 26 2016 at 9:52AM ET
Mr. Pina brings a great deal of heat to the debate about serving the underserved but, unfortunately, very little light. Roughly 100 million people are unserved or underserved by traditional depository institutions. This problem has become extremely acute during the past decade or so when regulators have made it increasingly difficult for regulated banks to make short-term loans to lower income people. Within the past two years, for example, federal regulators forced four large and very good retail banks to abandon deposit advance loans, which were extremely popular with their lower-income customers. These actions by regulators have fueled the growth of non-depository institutions dedicated to making small dollar loans to people who can't get them from government-insured depository institutions. Now activists are focused on trying to make life difficult to impossible for non-bank, small-dollar lenders. I note that Mr. Pina's organization competes for loans to the very same low-income customer base. By the way, Mr. Pina, I left the FDIC some 30 years ago.

Bill Isaac
Posted by billisaac | Friday, March 25 2016 at 1:52PM ET
I’m a payday lender and have worked in the industry for over a decade. Each day I see the good our small business does for people who need access to $500 right away. Our customers are good, hardworking people who are also fiercely independent and self-reliant. They see the value in the service we provide and recognize that we help them satisfy an immediate cash need. I applaud Mr. Isaac’s careful approach and I find the comments of Mr. Pina to be illustrative of the broader problem with the payday lending debate this country—too much demagoguery, too few facts.
Posted by Brian L | Thursday, March 24 2016 at 11:57AM ET
Re: FMCRC comments...And what is it, exactly, that a regulator could do to force the unbanked to use a bank? Or to force banks to bank the unbanked?

This is a classic case of people thinking the government knows best for individuals, that no rational person would ever purposely decide to use a payday lender, and that regulators have infinite powers to simply wave a regulatory hand and tell banks what to do.

The dirty little secret about the unbanked is that a large portion of them consciously chooses NOT to use a bank. Payday lending better fits their needs, for whatever reason. The fact that people are unbanked isn't prima facie evidence that they are a victim of anything, have to be saved, especially from themselves, or that banks or regulators have done anything wrong.

People make choices. It's that simple. This whole unbanked thing is being way overthought with way too much time spent on it.
Posted by RegGuy | Thursday, March 24 2016 at 11:55AM ET
A little hard to make out fmcrc's comments. He seems sympathetic to the needs of small-dollar borrowers, but seems to suggest that the best way to help them is to make credit unavailable. If institutions can make money supplying those needs, then there will be more supply of credit to meet those needs.
Posted by WayneAbernathy | Thursday, March 24 2016 at 10:57AM ET
you have got to be kidding me. Your (as well as the comment by famullar) is disgusting with your complete lack of sensibility towards the suffering of others. You can accept these pay day loans and terms because your lives are comfortable and you do not have to worry about which bill to pay since you do not earn enough to pay them all. The bare essentials. To say it is ok or worse by this idiot who says just pay on time (guy you better find a heart or soul) is lacking complete and utter understanding of the lives of those who have no choice but to use pay day lenders because you as a regulator completely failed to ensure banks provided services to the unbanked. your failure as a regulator led to the rise of pay day loan sharks. Oh by the way now you make money from those you use to regulate. How convenient. I will fight people like you to the gates of hell and back before I allow your way of thinking to create economic slaves of these low income people who only want a better life. Al Pina Chair FMCRC
Posted by fmcrc | Thursday, March 24 2016 at 7:02AM ET
Pay well and in time you avoid many headaches
Posted by famullar | Thursday, March 24 2016 at 5:48AM ET
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