The Consumer Financial Protection Bureau will unveil sweeping federal regulations Thursday for payday lenders that could open the door for banks to offer short-term, small-dollar loans.
The agency's plan is expected to hew closely to a 57-page outline released last year as part of a small-business review panel. The impact of the proposal will be felt beyond payday and installment lenders, potentially touching a wide range of financial institutions including banks, credit unions and fintech companies.
"When you think about what this really is, there are regulatory pressures, financial return pressures and community and social pressures around this thing," said Ben Morales, the CEO of QCash Financial, a credit union service organization owned by Washington State Employees Credit Union in Olympia.
Following are four issues to watch when the CFPB formally unveils its proposal at a public field hearing in Kansas City, Mo.
Opening the Door for Banks?
Banks have largely stopped originating small-dollar consumer loans after the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency discouraged deposit advance products in 2013. Prudential regulators have long believed short-term loans are expensive to consumers and carry reputational risks.
But consumer advocates are pushing for an exemption in the CFPB proposal from certain underwriting requirements for longer-term loans of between 46 days and six months. The exemption would open the door for banks to compete if they can structure loans in which the monthly payment does not exceed 5% of the borrower's gross monthly income.
At least three U.S. banks are preparing new small-dollar installment loan products that would compete directly with payday and installment lenders.
Alex Horowitz, a senior research officer on the small-dollar loan project at the Pew Charitable Trusts, said banks could potentially disrupt the entire payday market by enabling consumers to borrow at a much lower price.
"Banks are preparing to enter the market with loans that cost six times less than payday lenders," Horowitz said. "That would be the most important development coming out of the rule because we would see an entire market shift. But that won't happen without the 5% payment standard."
Fintech Comes into the Fold
A major concern for short-term, small-dollar lenders is how the CFPB will define who is covered by the plan and what types of loans fall under the proposed regulation.
Many marketplace lenders rely on alternative data or their own proprietary data to underwrite loans. Depending on how prescriptive it is, an ability-to-repay requirement "could be a game-changer for them," said Joe Rodriguez, of counsel at Morrison & Foerster, who formerly worked in the CFPB's Office of Fair Lending.
"There's a real concern in the fintech and marketplace lending space that their business will be covered by the rule and it could constrain what they do," Rodriguez said.
If marketplace lenders "have to tighten their credit standards, it can hurt them given the environment they're currently in," Rodriguez said. "While it's generally not going to help their ability to attract capital, there is actually an opportunity for those companies that can show they are really on top of the new requirements."
If the proposal covers fintech and marketplace lenders, it would make sense from an efficiency standpoint, as the agency would not have to issue another large-participant rule to cover those firms, he said.
Another State Push
In anticipation of the federal regulations, some experts say payday lenders already are shifting to longer-term loans. The CFPB has repeatedly stated that the structure of payday loans forces some consumers to fall into a cycle of debt in which they have t take out new loans to pay off old ones.
Some of the 32 states that regulate payday loans do not allow variations on the product, said Dennis Shaul, chief executive of the Washington-based Community Financial Services Association of America, a leading trade group for short-term lenders. The other 18 states have no laws regulating payday loans.
Because of the various state laws, payday lenders are asking some states to allow loans with longer terms, declining balances and lower interest rates.
"We are trying to introduce legislation that will allow customers to borrow but in a different format," Shaul said. "This is a product with too much stress on it, and its use should be more confined and that's why we're turning to state legislators to get a platform for more products out there."
Consumers taking out a payday loan typically are charged $15 for every $100 borrowed, with the loan due in one lump sum on a borrower's next payday. The effective annual interest rate is 400%. By comparison, a $1,500 installment loan has an average monthly payment of $125 and is due after 15 to 18 months.
Industry groups are also concerned that the CFPB's proposal will not make a distinction between regulated and unregulated operators.
The plan "won't eliminate payday loans because we will still have offshore entities," Shaul said. "The real danger is this rule could move borrowers to unregulated online payday lenders, which ought to be a concern for public policy and for those looking at unfair competition, because these entities are outside the reach of the law."
The industry has suggested universal registration of lenders through a federal registry or those run by roughly a dozen states, said Jamie Fulmer, senior vice president of public affairs at Advance America, a Spartanburg, S.C., small-dollar lender.
He said the industry is expecting a 60% to 80% reduction in payday loan volume, based on the CFPB's outline released a year ago.
'Cooling Off' Period
A likely key element of the proposal would require that lenders demonstrate a borrower has the ability to repay the loan. But the bureau is expected to give lenders a second option that would allow them to comply with limitations that restrict how often a loan can be rolled over or reissued within a certain time frame.
The industry opposes the ability-to-repay requirement.
"We are very far apart on the ability to repay, the number of loans a year and what is harm and how do you measure it," Shaul said. "They find harm where we don't believe it exists. They believe there is a cycle of debt they can define … but it's hard to assess harm without looking at how the money was used. Their arbitrary cutoffs in numbers and rationale don't parse well."
In its outline, the CFPB said it was considering requiring a 60-day cooling-off period before a consumer could get another payday loan after a certain amount of loans were issued.
Bill Himpler, executive vice president of legislative affairs at the American Financial Services Association, said installment lenders are concerned about the restrictions.
"I see this almost as a civil rights issue," Himpler said. "Would a credit card customer stand for a cooling-off period where after you make a May payment you have to wait two months before using your credit card again?" The CFPB "is not treating all borrowers equally."
There also is an additional cost to lenders that have to re-establish a relationship with the borrower two months later, he said.
"The bottom line is, we need some flexibility," Himpler said.