The Consumer Financial Protection Bureau (CFPB) plans to crack down on payday lenders, moving to regulate high-interest, low dollar loans that are made by storefront lenders to an estimated 12 million lower-income households living paycheck to paycheck.
The $38.5 billion market is currently left to the states to regulate, but now the government wants to get involved. The payday rule, proposed by the CFPB will impose a complex set of requirements on the payday industry, mandating that lenders assess a borrower's ability to repay and making it harder for lenders to roll over loans, a practice that often heads to escalating borrowing fees the WSJ reports. The rule will go through a 90-day public comment period, with a formal rollout expected early next year.
From the WSJ
Under the new rules, the CFPB imposes a series of “full payment tests” on lenders, customized to different types of loans, requiring the firms to do extensive due diligence to see if borrowers can repay their loans. Currently, few payday lenders do such underwriting, saying it is too costly.
Lenders would be required to go through another review of borrowers’ finances if the borrower seeks to renew or extend the loan.
Congress prohibited the CFPB from setting a direct interest rate cap for federal rules, so the agency is seeking to change the lending practices by other means. To regulate payday lending, the bureau is for the first time relying on its authority to prohibit "unfair, deceptive, or abusive acts and practices." Marking an area of regulation that is much more nuanced than where it had been given a clear mandate by congress such as mortgages and credit cards.
Payday lenders of course oppose the pending rule, saying it would force many out of business and leave low-income borrowers without much needed credit. Opponents of the rule also cite a January survey by Bankrate.com showing that only 37% of adult Americans have the necessary savings to cover a $500 car repair or $1,000 emergency room bill.
"Congress told the CFPB to regulate payday, not annihilate it, and so much of what they are proposing represents annihilation" said Dennis Shaul, chief executive of the Community Financial Services Association of America, the primary industry group of payday lenders.
Even some advocates of new federal regulations on payday lending criticize the rules, saying the complexity and tight strings would discourage banks and others from entering the market, possibly leaving a void. "The CFPB proposal misses the mark" said Nick Bourke, director of small-dollar loan research at Pew Charitable Trusts, who was briefed on the proposal. Bourke added that the rules effectively lock out small-dollar loans from banks.
CFPB Director Richard Cordray said that "too many borrowers seeking a short-term cash fix are saddled with loans they cannot afford and sink into long-term debt. It's much like getting into a taxi just to ride across town and finding yourself stuck in a ruinously expensive cross-country journey."
Cordray is correct in his assessment, but the critical element here is how to help those low income earners if payday lending goes away. If those individuals get frozen out of financial institutions, where will they turn for short term cash in order to pay those one-off emergency items. This is the question that will ultimately have to play itself out throughout this process. It is a potential issue because as more and more of the only available jobs are on the lower end of the pay scale, or worse, the jobs for rural Americans disappear as we discussed previously, there will be a need for those individuals to access credit, and if it's not there, real social unrest will manifest itself.