The Consumer Financial Protection Bureau faces a tough balancing act as it seeks to issue a proposal to rein in high-cost payday loans.
If the agency goes too far in restricting short-term, small-dollar loans, there will be a huge backlash from payday lenders and on Capitol Hill, from both Republicans and Democrats. But if the agency fails to stop the most abusive practices, consumer groups will view the first national standards on payday loans as a failure.
A chief concern is what will replace payday lenders if federal regulations force many to shut down.
"One of the big issues is, if this industry shrinks, who is going to replace them?" said Gil Rudolph, co-chair of the financial regulatory and compliance practice at Greenberg Traurig. "There's going to be an inability of many consumers to meet their financial needs, especially in an emergency."
If the CFPB sticks to an outline of its proposal released a year ago, as many as 60% or more of storefront payday lenders could shut down, said Dennis Shaul, chief executive of the Washington-based Community Financial Services Association of America, a leading trade association for short-term lenders.
If that happened, consumers would have nowhere to go for emergency funding, he said. Many would likely resort to unregulated online lenders.
"We're concerned that small operators would be driven out of business and small operators are where the most entrepreneurial, novel ideas come from, and where intelligent cost-cutting comes from," Shaul said.
But consumer groups are concerned that if the CFPB's proposal does not go far enough, borrowers will continue to be harmed.
The 2015 outline was the public's first real look at the CFPB's approach, yet the agency did not formally release the proposal then since the payday lending rule is subject to federal law requiring that the bureau first gather feedback from small businesses. The CFPB is expected to issue a plan by May or June. The Small Business Review Panel is expected to release its findings around the same time the CFPB issues its proposed rule.
Based on the outline, the bureau has sought to target specifically repeated cycles of reborrowing. The CFPB's research found that 82% of payday loans are rolled over or followed by another loan within 14 days. In addition, 75% of payday loan fees were generated by borrowers who took out more than 10 loans a year, the bureau's analysis found.
In its outline, the CFPB said it is weighing giving lenders two options: either verify the borrower's ability to repay a loan, or comply with restrictions on how often a short-term loan can be rolled over or reissued within a certain time frame. Lenders could opt for alternatives that allow for less underwriting and documentation.
But Paul Leonard, the California director at the Center for Responsible Lending, said that's a mistake. He said the ability-to-repay standard should apply to all loans.
"There shouldn't be an option that doesn't require the borrower's ability to repay," Leonard said. The CFPB is "concerned about trying to preserve some level of activity in a marketplace where lenders have a deep presence and where a lot of borrowers are using payday loans."
The plan would be the CFPB's first rulemaking under the authority given by the Dodd-Frank Act to prohibit unfair, deceptive or abusive acts or practices, commonly known as UDAAP. The regulations would cover payday loans, vehicle title loans, deposit advance products and certain high-cost installment and open-end loans.
The agency is also concerned that lenders that collect automatic repayment from consumers' banks accounts or paychecks, or those with liens on consumers' vehicles, have less incentive to carefully underwrite loans causing greater risk to consumers.
But the CFPB acknowledges that its restrictions would lead to "a substantial reduction" in the volume and revenue of payday loans. To survive, lenders would likely have to restructure their business models. Many are likely to diversify toward longer-term installment loans with smaller periodic payments.
"It is likely the case that the number of monoline stores that could operate profitably within a given geographic market would decrease," the CFPB said. "The proposals under consideration could, therefore, lead to a substantial consolidation in the short-term payday and vehicle title lending market."
Richard Horn, a former senior counsel and special adviser at the CFPB who now runs his own law firm, said there is a chance that the proposal would be so onerous that current lenders would not be able to comply.
"They are creating a complex regime, and it's so burdensome with the time frames and documentation that is required that it is going to be a game changer" for the industry, he said.
Yet consumer groups say that rather than shut down, many lenders will diversify into other products, or will consolidate branches that end up serving more borrowers. In Colorado, for example, which has some of the strictest state laws, lenders serve about 1,150 customers per store, which is double the amount of some other states, according to research by the Pew Charitable Trusts.
"There's an active shift toward super-high-cost installment loans that also have access to a borrower's account, and that's where the payday lending industry is preparing to go," Leonard said.
Others said having fewer companies would open up the market to other types of lenders to provide short-term credit. Lauren Saunders, the associate director at the National Consumer Law Center, noted how some alternative lenders increased their market share in Montana after payday loan interest rates were capped in the state in 2010.
"We think the market will respond and people will look to alternatives like credit unions," Saunders said. "Just like in the mortgage crisis, instead of consumers getting a no-doc loan, they will look for a better alternative."
The ability-to-repay standard would require that lenders upgrade their technology to verify a consumer can repay the loan, and that they can meet major financial obligations and living expenses without reborrowing.
Small lenders that do not already have a records system would have to invest in technology, train staff and develop policies for using the system. The added costs would further hurt lenders' profitability, some lawyers said.
"There will be greatly increased costs on business and a number of lenders would fail," said Benjamin Diehl, an attorney at Stroock & Stroock & Lavan in Los Angeles, who worked for many years in the California attorney general's office. "There is a real question of the impact this will have on the availability of short-term loans."
Shaul suggested that the rules could result in more business going to companies "operating offshore" that "are, without exception, real sleaze operators." He said for consumers needing credit, companies like those in his trade group are the only prudent option.
"We have no business arguing that this product is good for everybody; it is not. But the demand is there and it cannot be denied," Shaul said. "Our critics don't want to admit that apart from us, there are few formalized channels for consumers to seek an alternative to payday lending."