The Consumer Financial Protection Bureau's rules largely reflect what the agency proposed last year for an industry where the annual interest rate on a payday loan can be 300 percent or more. The cornerstone is that lenders must now determine before giving a loan whether a borrower can afford to repay it in full with interest within 30 days.
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A key goal is to prove that borrowers, who are often in dire financial situations, are able to pay without having to renew the loan repeatedly. The rules would set limits on the number of times a borrower could renew. Because studies by the CFPB have found that about 60 percent of all loans are renewed at least once and that 22 percent of all loans are renewed at least seven times, this cap is likely to severely wound the industry's business model. In California, the largest payday loan market, repeat borrowers made up 83 percent of the industry's loan volume.
The CFPB estimated that loan volume in the payday lending industry could fall by 55 percent under the new rules. The industry, which operates more than 16,000 stores in 35 states, will likely see thousands of payday lending store closures nationwide. Regulation of the sector has been largely left to the states, 15 of which effectively ban payday lending or auto title lending due to the caps on interest rates.
"Too often, borrowers who need quick cash end up trapped in loans they can't afford. The rule's common-sense ability-to-repay protections prevent lenders from succeeding by setting up borrowers to fail," CFPB Director Richard Cordray said in a statement.
While the industry may garner little sympathy from the public, there is an economic need for small dollar, short-term loans. Roughly 12 million people took out a payday loan in 2010, according to the Pew Charitable Trusts. And there's a concern that those who use payday loans might turn to other high-cost ways of making ends meet, like using pawn shops.
"The CFPB's misguided rule will only serve to cut off their access to vital credit when they need it the most," said Dennis Shaul, chief executive of Community Financial Services Association of America, a trade group for the payday lending industry. "The rule is not only misguided, it's hideously complex for loans of a few hundred dollars."
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In addition to the "full payment test" and the limits on loan renewals, the CFPB rules would also restrict the number of times a payday lender can attempt to debit a borrowers' account for the full amount without getting additional authorization. This is because many payday loan borrowers end up overdrafting their bank accounts, which in turn incurs fees. Or worse, they end up having to close their bank accounts due all the overdrafts.
Liberal-leaning consumer advocates, who have long pushed for additional regulations on the industry, cheered the decision.
"Payday and car title lenders profit from repeatedly dragging hard-pressed people deeper and deeper into debt, and taking advantage of families when they are financially vulnerable," said Lisa Donner with Americans for Financial Reform. "Curbing the ability to push loans that borrowers clearly cannot repay is a key protection."
But the payday lending industry has a significant lobbying presence in Washington, and Republicans tend to be hostile toward any regulations proposed by the CFPB, which was created under the Obama administration.
Bills pending in Congress would severely restrict the types of regulations the CFPB can propose, and Republicans have called for Cordray to be fired. Another bill would roll back other consumer protections the agency has finalized, most notably the rules ending what is known as forced arbitration, where banks and financial companies can force consumers into third-party arbitration instead of allowing consumers to file class-action lawsuits.
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Before Thursday's announcement, the only federal regulation that applied to the payday lending industry was the Military Lending Act, which places interest-rate and debt-collecting restrictions on loans to servicemen and women. This would be the first time all consumers would be impacted.
The CFPB's rules imply that it wants banks and credit unions to take over the small-dollar lending industry. Financial companies are exempt from the rules if they make less than 2,500 loans a year and earn less than 10 percent of their revenue from these types of loans, which fits into the bank and credit union's business model. The Credit Union National Association, the trade group for the credit union industry, said they are "closely analyzing" the CFPB's new rules.
Meanwhile, another federal regulator, the Office of the Comptroller of the Currency, announced that it was rolling back some restrictions it had placed on payday lending-like products known as deposit advance products. This could allow banks to step into the payday lending space.
The new rules will take effect 21 months from when they are published in the Federal Register, which usually happens within a week of an announcement.