Alexander Foxx, Associate Member, University of Cincinnati Law Review
Introduction
On October 5, 2017, the Consumer Financial Protection Bureau (CFPB) finalized a rule that restricts the lending autonomy of payday loan institutions.[1] The CFPB receives its legal authority to promulgate such rules from the Dodd-Frank Act.[2] These restrictions are opposed by industry members claiming the new rule restricts credit to individuals who need payday loans.[3] The rule: (1) protects vulnerable members of the population; (2) forces updates to the payday lending industry, expected and required in other financial institutions; and, (3) enforces accountability on payday lenders and borrowers. Given that borrower accountability and equitable distribution of regulations—signified by the second and third aspects of the rule listed above—are often supported on a bi-partisan basis, support for this rule should be widespread.
This article first examines key provisions of the new rule and the impetus behind the rule’s publication. The article then examines why views opposing the new rule are misplaced.
The Rule
The rule was finalized on October 5, 2017 and is titled “Payday, Vehicle Title, and Certain High-Cost Installment Loans” (the Rule).[4] The Rule applies to institutions that make covered loans.[5] Covered loans are loans made to a consumer “primarily for personal, family, or household purposes.”[6] The loans are often informally referred to as “payday” loans. This section will focus on three of the larger provisions of the rule: (1) restriction of debt traps; (2) restriction of payment penalties; and (3) requirement of information reporting.
The most notable portion of the Rule[7] is its regulation of “debt traps” posed by payday lenders.[8] Debt traps occur when an individual is granted a loan that they cannot repay and must obtain a second loan to repay the first.[9] This leads to a spiral of debt which, for many individuals, may be difficult to escape. The Rule requires that payday lenders undergo an examination of the borrowers’ finances to determine whether the borrower can “make payments for major financial obligations, make all payments under the loan, and meet basic living expenses” during the term of the loan and for 30 days following the termination of the loan.[10] This is referred to as the “full-payment test.”[11]
The Rule makes exceptions to the full-payment test. Two significant exceptions are: (1) short-term, small loans; and (2) loans made from smaller lending institutions.[12] If a loan is under $500, it may not be subject to the full-payment test.[13] However, these smaller loans cannot be offered to borrowers who have other significant outstanding loan balances or have recently obtained a prior loan not covered by the full-payment test.[14] The Rule also exempts certain lenders from the full-payment test.[15] Specifically, “a lender who makes 2,500 or fewer covered short-term or balloon-payment loans per year and derives no more than 10 percent of its revenue from such loans” will not typically be subject to the full-payment test.[16]
A second notable provision of the Rule is its limiting of withdrawal penalties.[17] When lenders are unable to withdraw the due amount from a borrower’s account, a fee is imposed on the borrower by the institution at which the borrower has an account.[18] This is similar to overdrafting a checking account. Repeated failed attempts to withdraw could lead to substantial fees for the borrower. The rule requires that: (1) lenders give written notice before attempting to debit the borrowers account; and (2) lenders must stop attempting debits after two unsuccessful attempts and wait for approval from the borrower.[19]
Third, the Rule imposes information reporting obligations on payday lenders in order to monitor compliance.[20] The Rule institutes this requirement to obtain information about the loans the institution provides to its borrowers.[21] Information that must be reported includes the amount of the loan, the minimum loan payment, and the term of the loan.[22] This reporting requirement may prove the most burdensome requirement to payday lenders because it will demand resources to update record-keeping processes and reporting technology.
Impetus for the Rule
The Rule was instituted by the CFPB as a reaction to abusive lending practices by payday lenders.[23] The background to the Rule notes that payday lenders’ practices deviate sharply from typical lenders and target a vulnerable group of individuals who are living “paycheck to paycheck.”[24] The Rule aims to curtail “unfair and abusive” lending practices that prey on these vulnerable populations.[25] While the rule extends protections against payday loans to a national scale and sets a floor for regulating deceptive lending practices, it is not groundbreaking—courts have invalidated or restricted loans from covered lenders for a number of years.[26]
Opposition to the Rule is Unfounded
Opposition to the Rule could manifest through: (1) opposition to paternalism; (2) opposition toward restricting nontraditional credit; or (3) industry opposition.
Paternalism is not an appropriate objection to the Rule. Paternalism connotes a condescending regulation of a reasonable and rational consumer. An objection of the Rule’s paternalism presumes that payday loan agreements contain material that is reasonably easy to comprehend. This is not the case. Institutional loans are inherently esoteric. Terms such as “principal,” “interest,” and “balance” carry vastly different meanings in a lay lexicon than they do in the financial industry. Regulation of inherently complicated fields with a large potential for abuse[27] is not typically viewed as paternalistic and should not be viewed as such here. Further, even if the Rule is paternalistic, the vulnerable population merits the protection. Individuals in dire financial straits may desire, or require, a more acute level of oversight due to the pressure imposed on them by their financial situation. Bankruptcy law protects individuals in financial difficulty—there is no reason the Rule cannot also provide financial protection. It is widely accepted that mortgage loans are highly regulated for the protection of the borrower.[28] It should be equally accepted that payday loans, with annual percentage interest rates often exceeding 36%,[29] should also be regulated for the benefit of the consumer.
Industry opposition against the Rule is out of proportion. It seems odd that prior to the Rule, payday lenders had escaped extensive regulation, unlike traditional lending institutions. Traditional banks are subject to a plethora of federal legislation including the Dodd-Frank Act, capital requirements, money laundering regulations, disclosure regulations, Veteran Administration regulations, civil rights regulations, regulation from the Federal Reserve, regulation from the Office of Comptroller of the Currency, and regulation from the Federal Deposit Insurance Corporation. Yet payday lenders are subject to less regulation even though they advertise a much riskier product.[30] Opposition from the payday loan industry highlights the disparate regulatory burdens placed upon payday lenders and traditional lenders. Specifically, payday lenders have fewer regulations than traditional lenders, even following the passage of the Rule.
Finally, the view that restricting payday lending could tighten credit access for those who need credit is problematic. The New York Times noted that the Rule restrictions could decrease the number of loans made by 55%.[31] If this percentage reflects a decline in credit availability, many individuals could be negatively impacted. Presumably, many individuals resort to payday lenders because they do not quality for credit through a traditional lender. If this source of credit is eliminated, many individuals may be starved for necessary credit. However, the Rule addresses some of these concerns by exempting some organizations from the Rule and by loosening the Rule requirements for loans of small amounts.[32] This may properly regulate payday lenders while still providing access to credit.
Conclusion
The CFPB’s new Rule imposing restrictions on payday lenders is legally proper and productive policy. It is passed with the legal authority of the Dodd-Frank Act in furtherance of the CFPB’s mission of regulating financial institutions for the benefit of consumers. Opposition to the Rule is misplaced and does not serve as a sound reason for repeal of the Rule. The rule is not paternalistic, does not unduly restrict credit markets, and is not overly burdensome on the payday loan industry. The Rule should not be politically contested, but should be supported on a bi-partisan basis.
[1] CFPB, https://www.consumerfinance.gov/about-us/newsroom/cfpb-finalizes-rule-stop-payday-debt-traps/ (last accessed Oct. 16, 2017).
[2] DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT; FINANCIAL STABILITY ACT OF 2010, Sec. 1031.
[3] New York Times, https://www.nytimes.com/2017/10/05/business/payday-loans-cfpb.html (last accessed Oct. 17, 2017).
[4] CFPB, http://files.consumerfinance.gov/f/documents/201710_cfpb_final-rule_payday-loans-rule.pdf, 1, (last accessed October 19, 2017).
[5] CFPB, http://files.consumerfinance.gov/f/documents/201710_cfpb_final-rule_payday-loans-rule.pdf, 1509, (last accessed October 19, 2017).
[6] Id.
[7] Id.
[8] CFPB, https://www.consumerfinance.gov/about-us/newsroom/cfpb-finalizes-rule-stop-payday-debt-traps/ (last accessed Oct. 16, 2017).
[9] CFPB, https://www.consumerfinance.gov/about-us/newsroom/cfpb-finalizes-rule-stop-payday-debt-traps/ (last accessed Oct. 16, 2017).
[10] CFPB, http://files.consumerfinance.gov/f/documents/201710_cfpb_final-rule_payday-loans-rule.pdf, 1518 (last accessed October 19, 2017);
[11] CFPB, https://www.consumerfinance.gov/about-us/newsroom/cfpb-finalizes-rule-stop-payday-debt-traps/ (last accessed Oct. 16, 2017).
[12] Id.
[13] Id.
[14] Id.
[15] Id.
[16] Id.
[17] CFPB, http://files.consumerfinance.gov/f/documents/201710_cfpb_fact-sheet_payday-loans.pdf, 5, (last accessed Oct. 20, 2017).
[18] Id.
[19] Id. at 6.
[20] CFPB, http://files.consumerfinance.gov/f/documents/201710_cfpb_final-rule_payday-loans-rule.pdf, 8, (last accessed October 20, 2017).
[21] Id. at 8.
[22] Id. at 1548.
[23] CFPB, http://files.consumerfinance.gov/f/documents/201710_cfpb_final-rule_payday-loans-rule.pdf, 1, (last accessed October 20, 2017).
[24] Id. at 2-3.
[25] Id. at 1.
[26] See, e.g. State ex rel. King v. B&B Inv. Grp., Inc., 329 P.3d 658 (N.M. 2014); Daye v. Cmty. Fin. Serv. Ctrs., 233 F. Supp. 3d 946 (D.N.M. 2017); James v. Nat’l Fin., LLC, 132 A.3d 799 (Del. Ch. 2016).
[27] Such as the legal field.
[28] Regulators include Fannie Mae, Freddie Mac, and the Department of Housing and Urban Development, among others
[29] New York Times, https://www.nytimes.com/2017/10/05/business/payday-loans-cfpb.html (last accessed Oct. 20, 2017).
[30] Indicated by the much higher interest rates associated with payday loans
[31]See New York Times, https://www.nytimes.com/2017/10/05/business/payday-loans-cfpb.html (last accessed Oct. 20, 2017).
[32] CFPB, https://www.consumerfinance.gov/about-us/newsroom/cfpb-finalizes-rule-stop-payday-debt-traps/ (last accessed Oct. 20, 2017).
