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.