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The Consumer Financial Protection Bureau is currently seeking public comment on a proposed rule that would end what it calls the consumer "debt traps" that stem from payday loans with huge annual percentage rates and hidden fees. The regulation is expected to be challenged by advocates of the payday lending industry, however, over issues including whether the CFPB, an agency of the U.S. government, even has the authority to institute the payday loan regulation.
Joe Rodriguez, a lawyer from the Washington, D.C., office of Morrison & Foerster who represents financial institutions regarding consumer protection laws and regulations, recently sat down for a Q&A to discuss the CFPB's payday loan regulation proposal. Rodriguez discussed the details of the proposed regulation and the potential legal obstacles the CFPB faces in trying to institute the rule.
How is the Consumer Financial Protection Bureau's proposed payday loan regulation intended to protect consumers from falling into debt from payday lending?
Joe Rodriguez: It's very comprehensive. It's got a kind of general compliance mechanism for any lender that makes a payday loan -- there are short-term loans and there are long-term loans that are covered under the rule. Any lender who makes either of those types of loans would have to comply with what's known as an 'ability to repay' requirement, something that has been in place in both mortgage lending and credit card lending.
The basis of it is actually that the lender has to look into a consumer's income, a consumer's current debt burden, and then figure out whether this additional debt will work within the consumer's income. Will they still be able to make all the payment on their existing debt? Will they be able to make payments on this new debt? In addition, this particular rule also requires the lender to account for everyday living expenses like food and utilities and stuff like that.
Basically, it requires the lender to not only make all those inquiries, but actually verify the information. You have to get pay stubs. You have to pull a credit report. All of that is completely foreign to the payday lending industry. From that perspective, this requirement is really going to kind of change the game, so to speak, for your traditional or typical payday lender. It will make it, I think, a lot more difficult for borrowers to qualify for a loan. It's a real question whether the typical payday borrower can pass that 'ability to repay' requirement. From that perspective, it's going to kind of narrow the scope of ... the people that can qualify for a typical payday loan.
Will these rules as they are proposed be effective in protecting consumers from payday debt?
Rodriguez: I think it changes it a bit in that it will be effective for preventing borrowers from the excessive rollovers and situations where they are not paying down any of the principals in their loans. In that respect, it will protect consumers from that aspect of payday lending. I think it provides avenues for short-term credit, but kind of cuts off the aspects of it which I think the [CFPB] had found to be problematic.
It definitely does protect consumers from what some folks have viewed as a little more problematic aspects of payday lending while still ... allowing ways of short-term credit. For lenders, it's really going to require them to invest some money in technological solutions that will allow them to conduct these compliance activities. Right now, for payday lenders, there's really not a whole lot of underwriting so that requirement is going to be expensive for them.
What are some of the potential legal pitfalls the CFPB faces when trying to institute this proposed payday loan regulation?
Rodriguez: There are two that jump out at me. The first is that in the Dodd-Frank Act, in terms of the CFPB rulemaking authority, there are a number of requirements they have to meet and one is to look at the impact on the industry they are regulating and look at the impact on consumers in terms of access to credit. If I was a payday lender or a trade group representing payday lenders, I think that's where I would be looking to make my arguments: This rule is really going to severely curtail their industry and cause consumers in some aspects of the consumer market to not have access to credit, and the question is: What is the alternative for those consumers?
Do they get a loan and default? Are they turning to loan sharks and other less savory lenders? That's where there is an interesting legal question for discussion. The CFPB has put out a few studies where they have tried to make the case for why they thought the rulemaking was required. The one piece I haven't seen in the CFPB studies is ... some kind of economic analysis around the alternatives for consumers. If you are one of the consumers that have to roll over their loan multiple times, what happens to you? Where do you go? What becomes of your credit? Do you have to just live with a busted car and take the bus to work?
The other issue is that the CFPB is not allowed to set user limits, or set interest rates. There's a question of whether they have effectively done that anyway by saying that certain loans can't have an APR above 36%, defining covered loans in that way, and then defining some of the alternative methods of compliance with the rule using that 36% interest. There is a legitimate question around whether they kind of effectively have done that anyway, and I think that will be an interesting legal question for a court to look at in terms of whether, by putting in those 36% rate caps, the bureau has effectively set interest rates.
To learn more about finance industry regulations, read why regulators are focusing on companies' compliance culture and how the global financial system stability group FSB is taking a closer look at fintech companies.