Prior to the Consumer Financial Protection Bureau's proposal last month on payday, title and high-cost installment loans, I was both hopeful and concerned about the upcoming rules.
In crafting the proposal, the CFPB had the potential actually to help tens of millions of Americans who rely on these forms of credit. Ultimately, the CFPB plan could eliminate regulatory uncertainty, which might have helped spawn innovation and improved lending options. However, I was also concerned that the CFPB might overreach and the rules could have negative, unintended consequences.
I support the mission of the CFPB and believe that CFPB Director Richard Cordray is a thoughtful and intelligent public servant with a tough job to do. That said, the proposed rules appear to contain both things I hoped for and feared.
The main problem with the proposal is the likely impact on the lenders and customers who rely on single-payment payday lending. While far from perfect, payday loans are the only real-world source of short-term credit for lower-income Americans in many states. In the 35 states that allow single-payment payday loans, the proposed rules will eliminate access to credit for millions of working Americans, negatively impacting on people who rely on payday loans for unexpected expenses such as auto repair and healthcare.
I don't believe the proposed rules regarding short-term (single-payment) lending are fully justified under Dodd-Frank. Defining the origination of multiple single-payment loans as an "abusive" practice strains credulity. In some states, higher-risk credit provided nonbank lenders is limited to short-term loans, which would be effectively eliminated under the proposal, causing severe financial hardships for many. An obvious response is for states to allow longer-term loans, but many states might not be able to do so in a timely manner, and many of the most needy borrowers might be rejected for longer-term loans.
That said there are some noticeable benefits in the proposal for borrowers. The effect of the proposed rules on longer-term credit does seem noticeably better than on short-term credit. The proposed limit on how many times a long-term credit provider can make unsuccessful automated-clearing-house debits on a consumer's account seems like a reasonable solution to the harm caused by inadvertent overdrafts. Moreover, non-prime consumers will be helped by the requirement that lenders report to, and obtain information from, the credit bureaus. This will allow consumers who pay on time to improve their financial options based on successful payment history.
But these positives are outweighed by the CFPB's proposed underwriting requirements for loans that would be still be allowed. A large portion of the consumers who rely even on longer-term consumer credit would likely not be able to pass the CFPB's rigorous test for "ability to repay," leaving those borrowers without a regulated solution.
Rather than pursue a simple solution, the CFPB instead opted for a strategy of requiring lenders to complete a thorough "ability to repay" analysis prior to funding a loan. This approach may be in line with regulations governing other credit products, but it goes too far and is too complex for small dollar loans, especially from smaller lenders.
No matter where one stands on the rules, the difficulty of implementing them and fairly supervising the industry is significant. I worry about the CFPB's process to implement the "ability to repay" test and supervise lenders without creating unreasonable levels of uncertainty and costs for lenders.
One possible improvement would be for the CFPB to offer to "pre-authorize" affordability criteria developed by lenders in advance of the full implementation of the rules. Since the rules won't be implemented for a year or more after being published there should be time for the CFPB to provide this kind of guidance.
The CFPB deserves considerable credit for ignoring some of the worst suggestions from various sides of the issues. Among other things, it passed on the idea circulated by the Pew Foundation and others to create an exemption from the "ability to repay" test for loans with certain features, including a cap on monthly payments of 5% of gross income. This is an arbitrary payment ratio, which provides no information about a consumer's spending habits or total monthly expenses.
Unless the CFPB makes important changes, the rules affecting small-dollar credit will likely generate years of lawsuits from payday lenders. With nearly half of Americans living paycheck to paycheck and with the majority of the country now having no credit score or a nonprime score, improved nonprime products and services are desperately needed.
The CFPB should be lauded for putting forth thoughtful proposals for reforms in lending to subprime consumers. That said every effort should be made to make the rules simpler and less prescriptive and allow for innovation and technology to broaden available credit to millions of people who need it to manage their day-to-day finances.
William M. Isaac, former chairman of the Federal Deposit Insurance Corp., is senior managing director and global head of financial institutions at FTI Consulting. Isaac 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.