The Consumer Financial Protection Bureau's upcoming proposal to regulate payday and other short-term lenders will be an important step for consumer protection, but advocates are wrong to think the CFPB's actions are intended to or will have a positive impact on the quality of credit products for the underserved.
In fact, the rule's real impact will be to limit access to payday lending, while not enabling small-dollar lending alternatives for consumers. This is not the fault of the CFPB. The agency was never given the tools to push the creation of new and safe products. The bureau's mission is to regulate current providers.
While we wait for the CFPB's rules to be formally released, lawmakers and other regulators should begin now to focus on creating a coherent policy to increase the number of quality credit products.
Barring the enactment of a federal charter for nonbank lenders, in the shorter term Congress should act to expand Title XII of the Dodd-Frank Act. This provision, which has yet to be implemented, makes available federal subsidies to "eligible entities" to provide affordable small-dollar loans. But the problem is the law excludes for-profit, nonbank small-dollar lenders from participating. As the provision is currently written, only banks, Community Development Financial Institutions, tribal entities, and state and local governments can make loans utilizing the funding and terms provided in this title.
One practical solution would be for Congress to establish a special nondepository CDFI with the ability to preempt state law and charge up to 36% or operate under a framework similar to the Federal Deposit Insurance Corp.'s 2008 pilot program on small-dollar lending. The ability to cross state borders would allow this category of CDFIs to reach consumers electronically and reduce customer acquisition expenses. Economies of scale are crucial to make small-dollar lending viable. It would also make it possible for these entities to compete with national banks to create viable loan programs, something that is next to impossible in the current regulatory environment.
Earlier this year, Sen. Sherrod Brown, D-Ohio, the ranking member of the Senate Banking Committee, sent a letter to President Obama asking for funding in the administration's 2017 fiscal year budget proposal to help implement the Dodd-Frank small-dollar loan measures, specifically sections 1205 and 1206 of the law. The president's budget proposal ultimately called for $100 million for this purpose.
While efforts to spur implementation of the Dodd-Frank provisions are laudable, small-dollar loan options cannot be expanded without greater clarity from Congress. One thing that has not been addressed is the irreconcilable conflict between the need for innovative products and the supremacy of state laws in financial services matters when dealing with nonbank lenders. Nothing in what Congress or the president has done allows innovators to go beyond what is currently allowed under state laws, which by definition limits their ability to innovate.
The CFPB has an office dedicated to financial innovation, but here too, the lack of legal authority to empower lenders to make loans outside of the rules that already exist in the various states limits innovation.
We have surveyed a number of alternative lenders and asked their opinion on creating lending programs for the underserved. Their first question in response is always, "What state?" Interest rates and terms vary from state to state. Costs can become high when serving a marginal population with loan amounts that require vigilant underwriting and maintenance, and when operating under differing regulatory regimes.
For instance, Arkansas allows a maximum interest rate of just 17% for consumer lending. By comparison, the cap in Louisiana — a bordering state — is 36% for consumer loans of up to $1,400, 27% for loans of between $1,400 and $4,000, and 12% for consumer loans of more than $4,000.
These discrepancies create complexities that are barriers to new lending programs. Approaching new customers in additional states is important for building scale, but differences in state laws make it very difficult for current market participants to serve those who currently use payday loans.
The consensus among activists and government agencies, including the FDIC and the Department of Defense, is that a 36% APR is the preferred interest rate cap for small-dollar lending. We agree that 36% is a good guardrail for consumer protection, and it is already the rate cap for many states. But several states have caps significantly lower than this. While there is great disagreement over the propriety of rate caps, the reality is they exist and must be factored into the conversation. More important than a rate cap is a consistent set of rules for lenders so that commercially viable alternatives can be created.
There are installment lenders and other types of short-term credit providers that are looking at different approaches. One such lender, Access Personal Finance, an online lender specializing in employer-based loans, is interested in trying to underwrite loans at less than 36% for those with poor credit or less than perfect credit. Many of the lenders we have surveyed say they can work with a 36% rate cap. They point out that loan size and volume are the critical components in making these programs work.
In short, reining in payday lenders may protect consumers but it will not increase credit availability. If access to better credit products is the goal, lawmakers and regulators at both the state and federal level must adjust their thinking and approach and do more to encourage small-dollar credit providers.
Kevin B. Kimble is the principal of KBK Consulting Group, and the founder and director of policy development of the Financial Services Innovation Coalition, a group advocating on behalf of several nonbank small-dollar, mortgage and small-business lenders.