As political developments affecting the federal regulatory landscape continue, one key area that consumer financial services practitioners will want to monitor is the future of nonbank small-dollar lending regulation and enforcement. The Consumer Financial Protection Bureau (CFPB) has altered the small-dollar landscape in recent years, taking what was chiefly a state-regulated activity and making it a federal priority. The CFPB has taken enforcement actions against small-dollar lenders and proposed the first federal regulation expressly covering small-dollar lending.
But with the future of the CFPB unclear, also unclear is what will happen to small-dollar lending oversight. If it were to revert completely to the states, there would still be questions to answer; it remains to be seen what changes, if any, may take place at the state level. And even with the continued involvement of the CFPB, the states – and cities – still have a significant role to play. In any scenario, it seems certain that consumer advocates will continue to scrutinize how these loans are regulated. Providers of small-dollar loans should carefully watch developments in this area to evaluate the potential impact on their business.
Small-dollar lending — including payday loans, short-term installment loans, and car title loans, among the “alternative financial services” (AFS) often marketed to unbanked and underbanked consumers — has attracted interest from nonbank lenders, who see opportunity in meeting the short-term credit needs of consumers who lack access to credit cards or loans from banks or credit unions. But consumer advocates have criticized many of these services, especially payday and car title loans, because of the risk of abuse of vulnerable consumers through fees and interest rates that are higher than fees and interest rates for credit cards and traditional loan products. They argue that many consumers may be unable to repay the loans and become trapped in a cycle of debt as they extend the loans and/or take out additional ones. (There currently is no universal and explicit requirement at the state or federal level to take into account a borrower’s ability to repay this type of loan. And even though some states require payday lenders to take into account an applicant’s monthly income when underwriting a loan, the requirements for doing so are inconsistent across the states. For instance, some states require lenders to look at an applicant’s net monthly income, while others require lenders to look at the applicant’s gross monthly income.)
These concerns are not new. Before the CFPB came into existence, nonbank small-dollar lending was chiefly regulated at the state level, and pro-consumer commentators had long urged states to regulate this area more stringently. The states license and supervise many small-dollar lenders, and a patchwork of inconsistent state laws address matters such as permissible loan amounts, the interest rates and fees that may be charged, the number of times a loan may be refinanced or “rolled over,” and disclosures that must be provided. In response to consumer protection concerns, some states have changed their laws to significantly restrict, or even ban, certain small-dollar loan products. However, a number of consumer advocates continue to believe that the state law protections for consumers overall are insufficient because, for instance, some states do not limit the interest rates that may be charged, do not require consideration of ability to repay, and/or contain loopholes – and because they vary from jurisdiction to jurisdiction and so do not protect all consumers equally.
Enter the CFPB
Small-dollar lending has been one of the CFPB’s key focus areas since the agency’s earliest days. As the first federal financial agency to regulate nonbank small-dollar lending, the CFPB has taken numerous enforcement actions against small-dollar lenders penalizing a variety of conduct, such as inadequate or misleading disclosures. In June 2016, the CFPB, in the first exercise of its authority to issue regulations prohibiting unfair, deceptive, or abusive acts or practices (UDAAP), proposed the first federal regulation directly addressing small-dollar lending. The CFPB previously had opted to define UDAAP only through the precedents set by its enforcement actions.
Accompanying the proposed rule was also a Request for Information (RFI) asking additional questions about certain other high-cost, longer-term installment loans and open-end lines of credit that were not included in the June 2016 proposed rule, raising the possibility of additional rulemakings in the future. Comments on the proposed rule were due September 14, 2016, and responses to the RFI were due October 14, 2016. Over 570,000 comments were received in response to the proposed rule. As of this writing, no final rule or additional proposal has been issued. Given the number of comments received, as well as political changes affecting the CFPB, it will likely be a lengthy process to finalize any final rule or additional proposal.
As proposed, the rule sets forth several requirements for covered small-dollar loans including many payday loans, auto title loans, deposit advance products, and high-cost installment and open-end loans. Lenders generally would have to take steps to determine borrowers’ ability to repay any covered loan.
The proposed rule sets certain restrictions on making covered loans when a consumer either already has or recently had certain outstanding covered loans. It also limits the lender’s ability to repeatedly attempt to access the borrower’s bank account for the same payment when the first attempt fails, an action that can subject borrowers to multiple insufficient-funds fees. Unless the borrower provides new and express consent to do so, a covered lender’s third attempt to withdraw payment from a borrower’s bank account after two consecutive failed attempts to do so would be an unfair and abusive practice.
While the rule addresses many issues raised by consumer advocates, a number of critics have claimed that the proposed rule does not go far enough. A group led by the Center for Responsible Lending (CRL), Consumer Federation of America (CFA), and National Consumer Law Center (NCLC) submitted a comment letter on the Notice of Proposed Rulemaking (NPRM) proposing many changes to toughen the rule, such as broadening its scope, augmenting its ability-to-repay requirements, increasing restrictions on refinancing longer-term loans, and explicitly providing that “offering or collecting a loan in violation of state law is an unfair, deceptive, and abusive practice.” Such a rule would automatically make a state law violation a federal violation. In its comment letter, the Pew Charitable Trusts also suggested “a few strong fixes,” including “limiting loan payments to 5 percent of a borrower’s paycheck.”
The CFPB stated that the rule is meant to supplement, not supplant, state laws, in that it preempts state laws only to the extent that they are inconsistent with the federal rule, and so the rule would leave state usury laws unaffected. Specifically, the CFPB stated in the NPRM: “The protections imposed by this proposal would operate as a floor across the country, while leaving State and local jurisdictions to adopt additional regulatory requirements (whether a usury limit or another form of protection) above that floor as they judge appropriate to protect consumers in their respective jurisdictions.” A comment letter from eight state Attorneys General urged the CFPB to put this language in the final rule itself, to make clear that state usury limits and other laws would be unaffected by the rule.
It is important to note that the proposed rule also does not explicitly limit interest rates on covered loans, which is a key way that some states restrict small-dollar lending. Dodd-Frank section 1027(o) prohibits the CFPB from setting set such limits. This may bolster efforts to encourage some states to implement more stringent usury limits.
If the rule were finalized as proposed, even without the additional provisions such as those encouraged by these commenters, it would significantly change the regulatory landscape for small-dollar lending. It would set forth specific substantive requirements constituting violations of federal law, in addition to the other laws and regulations that the CFPB already has the power to enforce, such as the prohibition on UDAAP and the Truth in Lending Act (TILA), as implemented by Regulation Z. As evident from the CFPB’s series of enforcement actions against small-dollar lenders, these laws already provide the CFPB with strong tools to police activities that the CFPB finds harmful.
The CFPB has taken several enforcement actions relating to small-dollar lending, and against AFS providers such as pawnbrokers and check cashers. Reading through these actions is instructive as to the types of conduct that raise concerns for the CFPB and how the CFPB believes the conduct already constitutes violations of federal laws. Some actions have alleged violations of TILA, such as the action against five title lenders in Arizona for allegedly advertising a periodic interest rate for their loans without listing the corresponding annual percentage rate. A similar joint enforcement action by the CFPB and Virginia Attorney General cited a Virginia pawnbroker for violating TILA by failing to include all the costs of credit on each loan – interest, maintenance fees, storage fees, and clerical fees –in the finance charge and APR calculations. The CFPB has filed lawsuits alleging similar TILA violations against at least five other Virginia pawnbrokers.
Other enforcement actions have cited violations of the Electronic Fund Transfer Act (EFTA) as implemented by Regulation E, such as by making electronic withdrawals from consumers’ bank accounts for loan repayments without obtaining written customer authorization for the withdrawals. The CFPB has also targeted lenders that require loan repayment by preauthorized electronic fund transfers, in violation of EFTA prohibition of conditioning an extension of credit on the borrower’s agreement to repay through recurred preauthorized electronic fund transfers.
Even where disclosures have been given in compliance with TILA and the lender has complied with EFTA, conduct may be alleged to constitute unfair, deceptive, and/or abusive conduct. For instance, the CFPB cited a small-dollar lender for unfair and deceptive acts and practices through promises made to consumers that the CFPB states were not kept, such as the opportunity to graduate to lower-priced loans. In another action, the CFPB cited a payday lender for unfair and deceptive acts and practices related to its debt collection procedures. It is important to keep in mind that UDAAP in particular is a powerful arrow in the enforcement quiver, because an action can constitute UDAAP as long as it meets the particular standards for UDAAP, despite technical compliance with all other applicable laws.
A key takeaway here is that no matter the fate of the CFPB’s proposed rule, the CFPB already has enforcement powers to penalize conduct by small-dollar lenders under its jurisdiction.
Threats to the CFPB’s Continued Power
Whether the CFPB will continue to wield such powers over small-dollar lending – or any other activity – depends on a number of evolving factors in Washington.
Actions that the Trump Administration and Republican-controlled Congress might take to weaken the CFPB could impact not only the CFPB’s oversight of small-dollar lending, but also the agency’s operations more broadly.
While, to date, there have not been credible indications that Congress will rescind the existence of the CFPB altogether, actions short of that could still greatly undermine the CFPB.
A new CFPB Director, for instance, could take actions to scale back the work the CFPB has done in the small-dollar space or other sectors, such as by withdrawing the proposed rule, refocusing supervisory and enforcement priorities and resources away from small-dollar lending, or (on a grander scale) directing resources away from aggressive consumer protection overall. This becomes likelier if President Trump nominates someone on record as opposing the CFPB’s actions. The name of retired Rep. Randy Neugebauer (R-TX), an outspoken critic of the CFPB, has surfaced as a possible nominee.
We continue to monitor developments related to the fate of the CFPB and its proposed small-dollar lending rule and will continue to post updates as warranted. In the meantime, lenders should closely read the CFPB’s issuances in connection with enforcement actions and review their own practices in comparison. For instance, lenders should confirm technical compliance with laws such as TILA and EFTA, such as including all costs of credit in TILA disclosures the lender provides and properly obtaining consumer authorization before electronically debiting a consumer’s bank account for repayment of a loan. Lenders should carefully review their policies, procedures, and training materials for potential UDAAP violations as well.
Next: The Enduring Role of the States and Cities in Small-Dollar Lending