On March 26, 2015, the Consumer Financial Protection Bureau (the “CFPB” or the “Bureau”) announced that it will be considering rules imposing significant structural limitations and other requirements on payday and similar loans: (1) short-term (45 days or less) loans to consumers; and (2) longer-term (more than 45 days) high-interest rate personal loans (more than 36% measured by an “all in” annual percentage rate (APR) that is more inclusive than the Truth in Lending Act APR) where a lender has the right to collect from the customer’s paycheck or bank account, or where a non-purchase money loan is secured by the customer’s vehicle. This proposal would also require advance notice to borrowers prior to collecting repayment of these types of loans through borrower bank or credit union accounts, and would limit unsuccessful withdrawal attempts from borrowers’ accounts without additional authorization. According to the CFPB, this proposal would “end payday debt traps by requiring lenders to take steps to make sure consumers can repay their loans” and “restrict lenders from attempting to collect payment from consumers’ bank accounts in ways that tend to rack up excessive fees.”[1] In written prepared remarks on the announcement, CFPB Director Richard Cordray stated that “the proposed framework under consideration for this segment of the market is designed to achieve one crucial objective: to allow for responsible lending while ensuring that short-term loans do not turn into long-term cycles of debt.”[2] The CFPB proposals announced on March 26 would not restrict banks or credit unions from charging account overdraft fees, another area of CFPB scrutiny and potential rulemaking, but would cover deposit-advance products that banks have offered.

The proposal would substantially change the payday and similar small dollar lending markets, and likely lead to a significant reduction in overall lending activity for many of these products as they are currently offered.

Background

The Consumer Financial Protection Act of 2010 (the “Act”), Title X of the Dodd-Frank Wall Street Reform and Consumer Protection Act, grants the Bureau authority to issue rules, applicable to certain providers of consumer financial products or services, and their affiliated service providers, “identifying as unlawful unfair, deceptive, or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service.”[1] The Act also authorizes the CFPB to issue rules requiring certain providers of consumer financial products and services to disclose to customers the “features of any consumer financial product or service.”[2] The Bureau’s statements on March 26 indicate that it would rely on these powers, including to ban “abusive” practices.

Prior to issuing and implementing any final rule, the CFPB must, under the Small Business Regulatory Enforcement Fairness Act, seek input from small financial services providers through a Small Business Review Panel (the “Panel”). The March 26 proposals were issued by the CFPB as an “outline” to facilitate the Panel process. The Panel will report to the CFPB on the Bureau’s proposals within 60 days of convening. Following the conclusion of that preliminary process, the Bureau may begin the formal rulemaking process with a Notice of Proposed Rulemaking (“Notice”). The proposals released on March 26 include descriptions of the requirements under consideration and possible alternatives, but did not include the text of any proposed regulations. That regulatory text will be set forth in the Notice. Comments on the regulations ultimately proposed will be accepted after that Notice is issued, which may not occur for several months.

Lending Activities Affected and Restrictions Being Considered

The following two categories of lending activities would be subject to the rules that the Bureau is considering proposing:

• Short-term credit products with contractual durations of 45 days or less (a “Covered Short-Term Loan”); and
• Longer-term credit products with an “all-in” APR in excess of 36% where the lender obtains a “preferred repayment position” through (1) access to repayment through a customer’s account or paycheck or (2) a non-purchase money security interest in a customer’s vehicle (a “Covered Longer-Term Loan”). The Bureau’s contemplated “all-in” annual percentage rate for purposes of the proposal may include the cost of ancillary products such as credit insurance, memberships and other products sold along with the credit, rather than the APR calculated under the Truth in Lending Act.[3]

The CFPB’s proposals would include requirements for lenders to assess customers’ ability to repay both types of covered loans at the outset of issuing those loans, as well as restrictions on issuing loans based on customers’ prior borrowing activity. Below is a summary of the key aspects of the proposals, as set forth in the CFPB’s outline:

• Ability to Repay Determination: For Covered Short-Term and Covered Longer-Term Loans, lenders would be required to “make a good-faith, reasonable determination that the consumer has the ability to repay the loan without reborrowing or defaulting,” based on the customer’s income, major financial obligations and borrowing history on other covered loans issued from any lender.[4] The Bureau is intending to require that lenders report all Covered Short-Term and Covered Longer-Term Loans to a “commercially available reporting service” (not operated by the Bureau) that would enable lenders to check a consumer’s borrowing history with other lenders when performing ability to repay assessments.[5]
• Cooling-Off Periods: For Covered Short-Term Loans, the proposal would create a presumption that a customer lacks the ability to repay such a loan taken out within 60 days of a prior Covered Short-Term Loan. To rebut this presumption, the lender would be required to verify that the customer’s circumstances had changed since the prior loan, and that the change indicates the customer has the ability to repay any second or third loan (g., a recent pay raise).[6] A mandatory 60-day cooling-off period would apply after three consecutive Covered Short-Term Loans are issued.[7] For Covered Longer-Term Loans, the proposal would create a presumption that a customer lacks the ability to repay if the customer seeks such a loan to refinance prior debts, and a lender would be required to verify any change in the customer’s circumstances. Covered Longer-Term Loans with balloon payments (i.e., single payments more than double regular periodic payments) would be treated similarly to Covered Short-Term Loans with respect to the requirements for cooling-off periods.[8]
• Alternative Screening and Structural Limits for Certain Covered Short-Term Loans: Instead of applying the ability to repay assessment and cooling-off periods summarized above, the proposal would allow lenders to issue Covered Short-Term Loans of no more than $500 with certain additional screening requirements to verify income and borrowing history. In addition, the lender could not take a security interest in a vehicle as collateral, and the lender must offer a “taper-off” mechanism where the customer seeks up to three loans in sequence. The taper-off mechanism could be structured through a reduction of the loan principal for each consecutive loan, or a no-cost “off ramp” if the customer is unable to pay after the third loan, to allow repayment without further fees.[9] The Bureau believes that most short-term lenders would use this alternative method based on its simulations of existing data in order to avoid the costs associated with making a supportable ability to repay determination and avoid the restrictions on making successive loans.[10]
• Alternative Screening and Structural Limits for Certain Covered Longer-Term Loans: Instead of applying the ability to repay assessment and cooling-off periods summarized above, the proposal would allow lenders to issue Covered Longer-Term Loans of between $200 and $1,000 for 45 days to six months as long as they meet the requirements of the National Credit Union Administration’s Payday Alternative Loan Program,[11] as well as certain other screening requirements and structural limitations. In addition, lenders could issue Covered Longer-Term Loans for 45 days to six months that limit periodic payments to no more than 5% of a customer’s expected gross income as long as certain screening and structural limitations are met.[12]
• Loan Payment Withdrawals From Customer Accounts: The proposal would also require lenders to provide a written notice to customers at least three business days prior to initiating any attempt to collect repayment of a covered loan from customers’ checking, savings or prepaid accounts. Further, the proposal would prohibit lenders from making more than two consecutive unsuccessful attempts to withdraw amounts from customers’ accounts without obtaining additional payment authorization from those customers.[13]

Implications

The CFPB’s analysis is that the contemplated “restrictions would lead to a substantial reduction in the volume of covered short-term loans.”[14] That is likely to be the case, regardless of the specific terms of a final rule. Forms of payday lending are already effectively banned in 15 states, and those bans will continue, as will other stricter state requirements. However, the Bureau does not appear prepared to ban payday lending and similar products, as some have advocated, but to keep small dollar short-term credit available.

The Bureau’s contemplated nationwide commercial registry of short-term small dollar loans will likely be controversial from a privacy point of view. The contemplated use of an “all in” annual percentage rate that differs from the statutory definition set forth in the Truth in Lending Act may also spark controversy. With respect to deposit advance products offered by banks, the Bureau noted that recent guidance from the OCC and the FDIC have resulted in a sharp curtailment of the availability of these products. The Bureau sees its contemplated rule as a backstop if banking organizations decide to resume offering deposit advance products.

Finally, the Bureau’s citation to “abusive practices” rulemaking authority is significant. The CFPB has cited abusive practices as a basis for several enforcement actions, but not yet in a final regulation.

ENDNOTES

[1]           March 26, 2015 CFPB Fact Sheet: The CFPB Considers Proposal to End Payday Debt Traps, available at http://files.consumerfinance.gov/f/201503_cfpb-proposal-under-consideration.pdf.

[2]           March 26, 2015 Prepared Remarks of CFPB Director Richard Cordray at the Field Hearing on Payday Lending, available at http://www.consumerfinance.gov/newsroom/prepared-remarks-of-cfpb-director-richard-cordray-at-the-field-hearing-on-payday-lending/.

[3]           12 U.S.C. § 5531(b).

[4]           12 U.S.C. § 5532(a).

[5]           March 26, 2015 CFPB Small Business Advisory Review Panel for Potential Rulemakings for Payday, Vehicle Title, and Similar Loans, Outline of Proposals Under Consideration and Alternatives Considered, at 6, n.10 & App. B, available at http://files.consumerfinance.gov/f/201503_cfpb_outline-of-the-proposals-from-small-business-review-panel.pdf.

[6]           Id. at 7-8, 11-14, 20, 23-25.

[7]           Id. at 13.

[8]           According to the proposal, “[t]he Bureau believes that reborrowing before a loan payment is due or shortly after paying off a previous loan often indicates that the payments under the previous loan were unaffordable given the consumer’s other major financial obligations and living expenses.” Id. at 15.

[9]           Id. at 8, 15-16.

[10]          Id. at 12 n.18, 20, 24-25.

[11]          Id. at 17-18.

[12]          Id. at 45.

[13]          12 C.F.R. § 701.21(c)(iii).

[14]          CFPB Outline of Proposals Under Consideration and Alternatives Considered, at 20-21.

[15]          Id. at 28.

[16]          Id. at 40.

The full and original memorandum was published by Sullivan & Cromwell on March 30, 2015 and is available here.