Despite phased reopenings across the country, the economic fallout from the COVID-19 pandemic continues keeping unemployment too high and straining personal finances.
With the unemployment rate at 11.1% and a severe credit crunch ongoing, many people need access to affordable, short-term credit. While some may turn to bank loans or credit cards, more than 12 million Americans rely on payday loans each year to make ends meet. It’s telling that a number of states with mandatory stay-at-home orders have deemed payday lenders so vital to the economy that they’ve been declared essential businesses.
The good news is that the federal Consumer Financial Protection Bureau (CFPB) has just released a long-awaited rule governing payday loans, a final rewrite of the Payday, Vehicle Title, and Certain High-Cost Installment Loans rule. It retools the controversial payday lending rule put out in 2017 by Obama appointee Richard Cordray. The old rule would have stripped consumers of this source of credit and effectively forced them to choose between financial ruin or borrowing from illegal “loan sharks,” the kind that use unsavory methods to enforce loan terms.
The old rule was faulty and far from justified. It wasn’t based on consumer complaints or empirical survey data concerning consumer sentiment, and regulators failed to test the implications of the rule before imposing it. Beyond that, the welfare analysis supporting the rule was so flawed that the principal author of the research later disavowed it.
The worst provisions of the old rule were an onerous “ability-to-repay” requirement and the “payments” restriction that placed unrealistic limitations on a lender’s ability to collect payment from a borrower.
The ability-to-repay provision required lenders to determine a customer’s ability to repay a loan and their ability to still meet major financial obligations over the next month. That standard was especially nonsensical because if borrowers had an immediate ability to repay, they would have had no need to take out a payday loan in the first place.
As argued by Thomas Miller Jr. of Mississippi State University, “Though [the ATR requirement] may sound sensible, basic living expenses are exactly what many payday loan borrowers seek to cover — meaning the rule denies them the option until their financial situation improves.”
In the new rule, the CFPB ends the ability-to-repay provision but, unfortunately, falls short of also getting rid of the payments provision.
The payments provision, currently on pause pending the outcome of a lawsuit from the Community Financial Services Association, would prevent lenders from automatically charging a customer’s account after two failed attempts at collection to prevent insufficient funds fees. This is an unusual burden, because there isn’t any other product or service that requires extra re-authorization after a failed attempt at obtaining payment.
If not removed by the CFPB or the courts, the payments provision would threaten the business model of small-dollar lenders, especially online lenders. Since online lenders can’t obtain a postdated check like a traditional storefront lender can, they rely on having access to a borrower’s bank account. Without consumer collateral and with restrictions on the ability to service a debt, these lenders face increased risk of fraud, default or bad-faith borrowing. And if a lender can’t collect on their debts, they’re ultimately more likely to charge more and lend less.
While it’s disappointing that the CFPB didn’t take the opportunity to remove the payments provision, the decision to get rid of the ability-to-repay provision will go a long way in ensuring this industry can continue to meet the needs of the consumers they serve. Small-dollar loans may not be ideal for everyone, but they provide an important source of credit to millions of desperate and marginalized Americans. Ultimately, the CFPB’s action will help foster innovation and competition in this financial sector that has now, officially, been deemed essential.
• Matthew Adams is a policy analyst with the Competitive Enterprise Institute, a free-market public policy organization based in Washington, D.C.