The Consumer Financial Protection Bureau is considering various approaches to reforming the payday loan industry, The Wall Street Journal reported on Sunday.
The bureau is concerned about the short-term, high-rate debt consumers take on, sources said.
States typically have been responsible for regulating payday loan company practices. If the CFPB should take action, it would be the first time federal regulations were applied to this niche in the financial sector.
Consumer advocates have long been calling for some restraints to be imposed on providers of these loans. Interest rates tend to be astronomical, and borrowers frequently are unable to repay the loans within the prescribed time period. What happens more often than not is that they roll their loans into the next pay period, committing to a never-ending series of high-interest, short-term contracts.
The CFPB reportedly is considering approval of a “vanilla” type of short-term loan with underwriting criteria that would establish whether the borrower actually would be able to repay it — an approach similar to the mortgage qualification requirements put in place after the financial crash.
That is not the only model reportedly under consideration, however, and the CFPB might waive such underwriting requirements for borrowers who don’t tap payday advance loans very often, the Journal reported.
Pushback can be expected from the industry, which has been under fire for years. The payday lenders’ argument is straightforward: With so many Americans living from paycheck to paycheck, their services are necessary to meet emergencies.
Defanging the Predator
“There is clearly a demand for payday lending by unbanked consumers who have needs for short-term credit but do not have access to credit cards, home equity loans or other loan products,” said David Reiss, professor of law at Brooklyn Law School.
“At the same time, payday lending repayment terms are often seen as onerous and predatory, with annual interest rates that run in the hundreds of percent and with many customers stuck in a cycle where they roll over their high cost debt from one month to the next, accruing more interest and fees along the way,” he told CRM Buyer.
Given the mission of the Consumer Financial Protection Bureau, Reiss said, it is natural for it to attempt to develop a regulatory structure for the industry that would allow it to function — but not extract predatory profits from its customers.
The CFPB is aware of the need for these loans, said Jonathan R. Kolodziej, an attorney on the financial services litigation and compliance team at Bradley Arant Boult Cummings.
The bureau has been studying the issue and holding field hearings, including one in Birmingham, Alabama, where Kolodziej is based.
At the conference, which took place in January 2012, “Director Cordray emphasized the need for protections designed to help consumers and ensure a fair and competitive market for these products. Since then, they have conducted a substantial amount of research and have made many of their findings public. These studies show that there is a place, and a need, for this market,” Kolodziej told CRM Buyer.
A Place for Payday Loans
The CFPB has acknowledged that payday loans can work for consumers who have expenses that need to be deferred, Kolodziej said.
“The CFPB’s primary concern with these products seems to be that borrowers enter into loans that they do not have the ability to repay,” he noted. “They also believe that borrowers frequently do not understand the nature of the product and the risks associated with it. It appears that the CFPB’s conclusion is that these issues result in a significant number of consumers entering into arrangements that will inevitably lead to long-term indebtedness at a higher-than-expected cost.”
For those reasons, the proposed rules likely will target underwriting standards, disclosures and marketing practices, according to Kolodziej.
“The challenge they face is figuring out a way to enact regulations that prevent irresponsible lending,” he said, “while also ensuring that these products remain available to consumers who need short-term loans and actually have a substantial likelihood of being able to repay them.”