CFPB Pours Cold Water on Banks' Deposit Advance Hopes
The Consumer Financial Protection Bureau's long-awaited proposal to establish the first federal rules for payday, auto title and high-cost installment loans did not include a provision that banks had planned would allow them to compete by offering small-dollar installment loans.
At least three large U.S. banks are preparing to go to market with new small-dollar installment loan products in a move that could potentially disrupt the payday lending industry.
Favorable treatment under upcoming Consumer Financial Protection Bureau rules has led banks to signal interest in small-dollar loans. But if they can serve the market profitably, why aren't they already doing it?
If your car required a $400 repair tomorrow, could you afford it? According to the Federal Reserve, for almost half of Americans the answer is unfortunately no.
Millions of Americans live paycheck to paycheck and need help making ends meet. Yet regulators in Washington continue to chip away at products and services that provide short-term, small-dollar credit, thereby leaving consumers with very few and more expensive alternatives. Banks had been hopeful that the Consumer Financial Protection Bureau's small-dollar lending proposal would provide needed flexibility to institutions to provide consumers with better options. But the CFPB's just-released plan misses the mark.
Historically, federal banking regulators have encouraged banks to help finance these small-dollar consumer loans. For many banks, this is an ideal scenario: customers receive the services they want – and need – but remain in the well-regulated and supervised banking system. In response, some banks, working closely with regulators, developed a way to meet short-term lending needs through deposit advance products. These loans were carefully designed to ensure strong safeguards, like a highly predictive ability-to-repay analysis that took into account a customer's cash flow patterns and direct deposit history.
Deposit advance products were cheaper than payday loans, offered greater transparency, required substantial disclosures and compliance with federal law, received positive feedback from borrowers, and had low default rates.
Unfortunately, in 2013, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. proposed a very strict set of guidelines for banks that were offering deposit advance. This all but eliminated the product. Citing "safety and soundness" concerns as the reason to implement the stricter rules, the agencies nevertheless failed – then and now – to provide any clear evidence to support their actions. Although providers had offered these products for years and yielded positive reactions from consumers, the OCC and FDIC had made up their minds. The product was discontinued by nearly all providers.
Should we expect things to get better? Judging by the release on June 2 of the CFPB's proposal, the answer is no.
Before today, some bankers had expressed interest in reviving deposit advance offerings amid speculation the bureau was designing rules that would effectively encourage certain products under a specific set of conditions. That could include deposit advance. But we are concerned that the proposal now before us is still too restrictive for banks to want to offer these products.
It is important to keep in mind that small-dollar loans are not mortgages, yet the underwriting the CFPB has laid out in today's proposal is as stringent for a small-dollar loan as it is for a $500,000 mortgage. To provide a small-dollar loan under the bureau's provisions, banks would have to, among other things, verify a consumer's income, "major financial obligations" and borrowing history, mostly by way of third-party records. Using this information, the lender then has to make a determination whether the consumer has the ability to repay the loan after covering these other major financial obligations and expenses.
But this lengthy underwriting process ignores two considerations: (1) the cost of this process, and (2) the amount of time it takes to complete it. The former is prohibitive for banks, given the small amount of the loan, and the latter is something consumers generally do not have – time to wait for an extensive underwriting decision.
The bureau has proposed a "safe harbor" from these overly burdensome ability-to-repay calculations for loans that have a $500 cap on the first short-term loan and lower caps on two subsequent loans. They have also proposed to provide safe harbors for longer-term loans that fall in either one of two buckets. One is based on a National Credit Union Administration model. The other would allow lenders to offer loans that are payable in roughly equal payments with terms not to exceed two years and with an all-in cost of 36% or less. This does not include a "reasonable" origination fee, so long as the lender's projected default rate on these loans is 5%or less.
While avoiding the unrealistic underwriting requirements by way of these safe harbors would be helpful, these provisions will garner little interest due to strict usage constraints.
The bureau, itself, has acknowledged the provisions will severely constrict many forms of short-term liquidity. So, what happens to consumers who need the small-dollar lending products? The need for small-dollar credit will not simply go away. If the bureau issues a final rule regulating small-dollar lending that resembles today's proposal, most banks will be forced to stay out of this business altogether, perpetuating the unbanked problem and making it even harder for consumers to get on their feet financially.
Instead of creating nearly insurmountable obstacles for banks that seek to offer small-dollar credit, the CFPB should use this opportunity to work closely with our industry on practical ways to help consumers meet their short-term borrowing needs. Consumer protections should be central to any solution, and there should be markers for a consumer's ability to repay, limits on frequency of use and loan size, and "off ramps" for customers who find themselves stuck in a cycle of debt.
But these consumer protections should also be realistic. While deposit advance products offered today and in the past protect the consumer, the restrictions addressed in the CFPB's proposal will merely add to the inability of banks to produce small-dollar products. The proposal will continue to steer consumers away from the depository products that work and send them to nondepository alternatives that are more expensive and offer far fewer consumer protections.
Banks want to offer safe, sustainable products that will serve customers' needs. The rules for offering these types of loans need to provide for flexibility in underwriting and realistic expectations on product usage in order to meet a very specific need: fast, affordable, small-dollar loans. Consumer protections should be paramount and all stakeholders, working together, should be able to come to an agreement on products and services that fit the bill.
The current proposal does not reach that balance. We urge the CFPB to work with our industry and the prudential regulators to find solutions that actually will work.
Richard Hunt is the president and chief executive of the Consumer Bankers Association. He can be found on Twitter @cajunbanker.