CBA Comment Letter on CFPB's Proposed Small-Dollar Rule

 

 

October 7, 2016

 

Submitted Electronically:  FederalRegisterComments@cfpb.gov

 

Ms. Monica Jackson

Office of the Executive Secretary

Consumer Financial Protection Bureau

1700 G Street, NW

Washington, DC 20552

 

Re:  Docket No. CFPB-2016-0025 / RIN3170–AA40 - Payday, Vehicle Title, and Certain High-Cost Installment Loans

 

Dear Ms. Jackson,

 

The Consumer Bankers Association (“CBA”)[1] appreciates the opportunity to provide our comments in response to the Consumer Financial Protection Bureau’s (“Bureau” or “CFPB”) notice of proposed rulemaking for payday, vehicle title, and certain high-cost installment loans (“Proposal”).  CBA strongly supports effective consumer protections and, specifically, the principles of choice, transparency and fairness in customer relationships.

 

CBA commends the Bureau for examining the small-dollar credit marketplace and how lenders in this market meet consumers’ need for credit.  We believe it is important that consumers receive the products they want and need at fair prices and on transparent terms.  We believe it is equally important to weed out bad actors that engage in fraudulent transactions or violate federal laws.  However, we believe the Bureau’s Proposal will discourage traditional depository lenders from remaining in or entering the market. 

 

The Bureau has proposed strict and prescriptive rules that will stifle progress in the small-dollar market.  They create conditions that call for a level and cost of compliance that is so great depository lenders simply will not be willing to make these loans.  These hurdles will only reduce efficiencies, restrict flexibility and reduce consumer options for small-dollar liquidity.  Only simple, flexible rules will foster the innovation needed to meet consumer demand for value, speed of fund availability and ease of application. 

 

We also believe the Bureau has failed to exercise proper authority to issue regulations prohibiting unfair, deceptive, or abusive acts or practices (“UDAAP”), has violated its prohibition on setting usury rates and has failed to present an adequate cost-benefit analysis to support a claim of consumer harm from bank-offered small-dollar products.

 

Accordingly, CBA urges the Bureau to withdraw the current Proposal and re-propose a regulation that:

 

  • is based on sound evidentiary conclusions, especially with regard to bank-offered products;
  • provides for reasonable and complete consumer protections;
  • provides for scalability and ease of administrative burdens to allow greater reach to the unbanked and underbanked;
  • provides an option for banks to offer small-dollar loans as a line of credit;
  • provides banks with a clear and easily applied standard that consumers will understand;
  • clarifies and interprets the interplay between the proposal and existing regulations issued by other federal financial regulators impacting small-dollar credit products, and
  • allows for flexibility to meet consumer needs through innovative and competitive credit options.

 

We appreciate the opportunity to share our suggestions and work with the Bureau as it considers the regulation of small-dollar credit. 

 

Discussion

 

Today, the need for accessible small-dollar credit for consumers is growing.  A stagnant economy has left consumers with less of a cushion for emergencies, tarnished credit scores, and reduced credit options; making access to reasonably priced small-dollar liquidity products even more important.  While various entry-level credit products exist to meet a wide range of these needs, including traditional credit cards, personal loans, and other forms of credit, many consumers unfortunately cannot qualify for them.

 

According to the Federal Reserve, nearly half of all American adults say they cannot cover an unexpected expense of $400.[2]  Similarly, a recent Bankrate article states “63% of American adults say they are unable to pay an unexpected expense with their savings…"[3]   A Center for Financial Services Innovation (“CFSI”) study found that more than a third of all households say they frequently or occasionally run out of money before the end of the month. Further, more than four in ten households struggle to keep up with their bills and credit payments.[4]  A group representing minority communities has found much to criticize in the Proposal.  The U.S. Hispanic Chamber of Commerce said in a statement the Proposal “ignores the needs of consumers, reduces access to credit for millions and it harms small businesses and the millions they employ.”[5]

 

In light of the high consumer need for these loans, the Bureau has encouraged depository institutions to enter or remain in the small-dollar lending market.  Historically, banks have developed products carefully designed to ensure strong safeguards at reasonable prices.  Bank-offered products are by nature well understood by the consumers who use them and are an important source of credit for consumers’ liquidity needs.  Banks would like to continue to make safe, affordable, and easy to access small-dollar loans to consumer in need. 

 

However, the Proposal and past guidance from other financial service regulators will make it difficult for banks to provide this type of lending, pushing consumers that need access to credit further outside of the heavily regulated bank space, leaving them with fewer, unregulated, and more expensive options, if any.  The need for this credit will not simply disappear with the expected constriction of the payday industry.  Consumers will ultimately pay higher prices for liquidity options or may face increased delinquencies and late payments.

 

In response to the Proposal, Pew Charitable Trusts said borrowers want three things – lower prices, manageable payments and quick approval – and asserted the Proposal goes “0-for-3” on those matters.[6]  We firmly agree.  The Proposal requires an excess of added manual processes including complicated income verifications and “reasonable” projections of future expenses. Other unsecured consumer loans do not require lenders to verify income; the consumer merely needs to state their income.  Verifying paystubs, tax forms, and other documentation introduces a manual process that the consumer may not be prepared for, delaying their access to much-needed funds and potentially driving them to an unregulated, unsafe provider to obtain it.

 

The Proposal calls for reports, restrictions and refunds of fees under certain conditions. In total, these provisions serve to negatively affect the pricing and fundamental purposes of small-dollar products and require countless hours of new compliance and oversight.  Under these conditions, with a high cost of compliance, the lenders the Bureau would like to see offer more affordable options as an alternative to payday providers simply will not be willing to participate in this space.  Only easily implemented standards will allow banks to make quick loans at reasonable prices, and we encourage the Bureau to create a clear lane for compliance minded lenders to step in to meet consumer needs. Taken together, these new restrictions and requirements would unduly hinder the expansion of small dollar lending products offered by banks and may lead to further retractions in the marketplace from banks offering existing small-dollar credit products. 

 

Furthermore, CBA firmly believes consumers benefit from the competition that banks add to the market for small-dollar credit products.  More providers in the market will ensure greater competition and innovation, which will ultimately lower the cost of small-dollar credit for consumers.  Overly restrictive regulations will lead to less competition and an increase in prices.  According to a study conducted by CFSI, continued market competition and product innovation would be advantageous in expanding small-dollar, short-term lending and may ultimately help lower the cost of these products for both providers and consumers.[7]  We believe forcing further monetary constraints on the consumers it intends to help directly contradicts the Bureau’s intent.  This principle is especially true for designing products and services that will provide the under-banked and unbanked with greater access to mainstream banking opportunities.

 

We encourage the Bureau to consider finalizing rules that will allow banks to participate in the small-dollar lending market.  The reality is that bank products can help countless U.S. consumers obtain access to much needed credit, rather than pushing them to unregulated pawnshops, offshore lenders, and fly-by-night entities.  The Bureau now has the opportunity to craft a rule that will support high quality small-dollar products that are made with confidence in the borrower's ability to repay; are structured to support repayment; are priced to align profitability for the provider with success for the borrower; create opportunities for greater financial health; have transparent marketing, communications and disclosures; and are accessible and convenient for borrowers.

 

We further urge the CFPB to continue to work with all stakeholders including consumers, depository institutions, and the federal prudential banking regulators to develop a sound, data-based foundation for a comprehensive regulatory and supervisory approach that avoids unintended adverse impacts on consumers.

 

  1. Legal Authority

 

In addition to the subsequent subsections on legal authority, CBA incorporates here all arguments made in its separately submitted joint-trade comment letter.[8] 

 

  1. UDAAP – Arbitrary and Capricious 

 

The Dodd–Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) authorizes the Bureau to prescribe rules under its UDAAP authority, as well as to enforce the Dodd-Frank Act’s UDAAP prohibition.  The Bureau has identified two practices as both unfair and abusive: to make a covered loan without reasonably determining that the consumer will have the ability to repay the loan, with some exception, and to attempt to withdraw payment from a consumer’s account in connection with a covered loan after the lender’s second consecutive attempt has failed due to a lack of sufficient funds, unless the lender obtains the consumer’s new authorization.  The Proposal marks the first time the Bureau has exercised its authority to issue regulations prohibiting UDAAP.

 

In exercising its authority, the Bureau has prescribed an incredibly prescriptive rule that would effectively create a narrowly tailored product designed to operate within a very constrictive regulatory scheme.  In general, we find this approach to be an inappropriate exercise of the Bureau’s UDAAP rulemaking authority.  Remedies for alleged unfair or abusive acts or practices should be tailored to those practices observed, not used to dictate product offerings filled with ancillary provisions (e.g. credit reporting, etc.) that have little if anything to do with the alleged harmful practices.  Unlike other financial regulators’ unfair, deceptive acts or practices (“UDAP”) rulemakings, the Bureau’s Proposal does not merely ban an identified practice; it imposes specific detailed underwriting methodologies and standards on the market, banning all other alternative underwriting methodologies and standards of these products as unfair and abusive.  However, the Bureau shows no evidence to support the sweeping legal conclusion that all alternative underwriting approaches would be unable to pass the unfair or abusive standard.  In creating such a detailed and proscriptive rule – one that prohibits all other ability to repay alternatives as per se abusive and unfair – the Bureau has exceeded its limited UDAAP authority, which should require a prior finding that the particular acts and practices in question are unlawful before being banned.  UDAAP rulemakings should only be used to ban specifically identified acts and practices.  The Bureau’s small dollar study did not investigate the relative merits of these now banned alternative approaches; it only relied on a broad review of the current marketplace.

 

Additionally, while the Bureau has amassed considerable data on the non-depository payday industry, it has failed to provide a comprehensive study of bank-offered products and their alleged harm to consumers.  There has been no showing that loans issued by depositories produce consumer harm.  In fact, we believe bank-issued loans are of great benefit to consumers and are not harmful.  They can help borrowers obtain needed liquidity for emergencies and avoid non-sufficient fund and overdraft fees, late payment charges and utility disruption.  To this point, we do not believe the Bureau has established that any consumer injury resulting from bank-offered covered loans exceeds the benefits they provide to consumers.

 

As a more practical matter, nowhere in the 1,300 plus page Proposal does the Bureau attempt to quantify the benefits to consumers of the proposed provisions, instead relying on repeated expressions along the lines of “it appears to the Bureau” or that the “Bureau believes” that “the amount of injury that is caused by the unfair practices, in the aggregate, appears to be extremely high.”  The Proposal cites numerous reports and studies to justify these views, but does not include any metrics in its analysis of benefits and costs.

 

In fact, the Bureau supports its assumptions based on the belief that all covered loans cause consumer harm.  This theme is unsupported and directly conflicts with a number of studies on the issue, which casts doubt on the notion that use of covered loans adversely affects borrowers.[9]   We believe this to be a fundamental flaw in the reasoning of the Bureau as under the Dodd-Frank Act a practice cannot be “unfair” if any injury it causes is outweighed by countervailing benefits.  And generally, an “abusive” practice must take “unreasonable” advantage of consumers.  It is hard to see how a practice can take “unreasonable” advantage of consumers if the benefits it provides outweigh any injuries it causes. 

 

Lastly, the Proposal is flawed because the incredibly restrictive ability to repay requirement (e.g. residual income analysis that requires verification using consumer reporting agencies registered with the Bureau) does not permit the application of other ability to repay approaches.  The Bureau never provides support for why other ability to repay analyses would not be sufficient to address the concerns it has about installment lending.  Taken together, we assert these flaws in the Proposal would appear to make the regulation arbitrary and capricious.

 

Accordingly, we believe the lack of a thorough cost-benefit analysis on these issues would be a necessary precondition of this type of contemplated regulation.  We stress the importance of the Bureau pursuing and releasing a robust cost benefit analysis before publishing the rule.

 

  1. Usury Limits

 

Historically, the Federal government has not sought to impose a nationwide usury rate.  Instead, usury laws have been largely left to the states to decide.  As a result, usury laws vary widely across the country and include a variety of exemptions and exceptions.  Any new Federal regulation of usury would likely have a large impact on these various statutes.  Partly as a result of this concern, section 1027(o) of the Dodd-Frank Act explicitly prohibits the Bureau from imposing a usury limit.

 

No authority to impose usury limit.  No provision of this title shall be construed as conferring authority on the Bureau to establish a usury limit applicable to an extension of credit offered or made by a covered person to a consumer, unless explicitly authorized by law.[10]

 

Under the Proposal, “longer-term” loans, with terms exceeding 45 days, are limited to loans that: (1) have “all-in” annual percentage rates (“APRs”) exceeding 36 percent; and (2) either create a security interest in the consumer’s motor vehicle or authorize the lender to collect payments by accessing the consumer’s bank account or paycheck.  As with short-term loans, the CFPB contemplates that lenders will be allowed to make longer-term loans either using an ability to repay analysis or, at the lender’s option, without an ability to repay analysis but subject to elaborate restrictions.

 

By setting a 36 percent trigger, or at 28 percent under the proposed alternative methods, the Bureau is creating a usury ceiling for loans that will fall within the guidelines of the rule and will severely restrict longer-term loans based on “all-in” APRs exceeding 36 percent.  At the same time, the Bureau leaves lower-rate loans outside the coverage of its contemplated rules, indicating that these loans are lawful, while those within the cap are not.  This is a clear violation of the Bureau’s authority under Section 1027(o) and we urge the Bureau to eliminate rate triggers.  Further, this usury provision creates a direct conflict with various state usury caps that are current law in a number of states.  This conflict will create confusion and potential regulatory compliance issues for banks looking to participate in the small-dollar credit market. 

 

  1. Proposal Provisions

 

            Despite the above-referenced issues regarding the Bureau’s authority, the proposed provisions offer little incentive for banks, and others, to enter the small-dollar market in any significant way.  The provisions outlined in the Proposal place what we consider to be unreasonable and unnecessary mandates on would-be lenders.  These issues, discussed in detail below, will make offering small-dollar loans unaffordable and incredibly burdensome to implement.  We urge the Bureau to reconsider this restrictive approach and to pursue lending options that offer easily applied standards that will enable lenders to make sustainable loans to consumers in need. 

 

Specifically, the Proposal would make it an abusive and unfair practice for a lender to offer a covered loan without conducting an onerous analysis of a consumer’s ability to repay the loan, making it difficult for any lender to offer affordable, easy-to-use products.  The level of underwriting complexity presented in the Proposal ignores the cost of providing small-dollar credit.  Requiring a burdensome level of underwriting will result in eliminating the ability of lenders to participate in the small-dollar market and, therefore, the result of the regulations would be unmet consumer needs. 

 

While the Proposal does allow for lenders to avoid the prescriptive underwriting analysis if they chose, these alternative methods call for restrictive and overly complex provisions that do little to provide banks with clear and easily applied standards.  While avoiding the unrealistic underwriting requirements by utilizing safe harbors would be helpful, these provisions will garner little interest from banks due to strict constraints that will inhibit consumer use and elevate complexity and cost for lenders. 

 

We urge the Bureau to consider safe and practical ways banks can serve their customers’ liquidity needs.

 

  1. Ability to Pay Analysis – Full Payment Test

 

The Proposal sets forth two general categories of loans: short-term loans and longer-term, high-cost loans (“covered loans”).  Covered loans include closed-end or open-end loans that are extended to a consumer primarily for personal, family, or household purposes.  Short-term loans[11] are those that have terms of 45 days or less; and “longer-term” loans[12] are those with terms of more than 45 days that have a “total cost of credit” exceeding 36 percent and either a “leveraged payment mechanism” or a security interest in the consumer’s vehicle.  The Proposal would restrict the ability of a lender to make a covered short-term or longer-term loan without determining upfront that the consumer will have the ability to repay the loan.  For all covered loans, the Proposal would require a lender determine whether the consumer can afford the full amount of each payment of a covered loan when due, while still meeting basic living expenses and major financial obligations (“full-payment test”). 

 

The Proposal’s full-payment test would require lenders making covered loans to verify the consumer’s income and borrowing history.  Using this information, the lender would then have to make a determination whether the consumer has the ability to repay the loan after covering other obligations and expenses.  Implementing the full-payment test will present an insurmountable underwriting standard for lenders.  While most lenders consider borrowers’ ability to repay to some degree, the Proposal creates an extremely complicated and unprecedented underwriting requirement common in mortgage lending, but unrealistic in the small-dollar space where lenders need to provide quick loan decisions to borrowers who have an immediate need for cash. 

 

To better illustrate, below is a comparison between ability to pay analyses for a covered loan and a $500,000 mortgage:

 

An ability to pay analysis for a covered loan would require:[13]

An ability to repay analysis for a half-million dollar mortgage would require:[14]

  • A “reasonable” determination of the borrower’s ability to repay the loan according to its terms;
  • The borrower’s current verified income;
  • A determination that the borrower’s residual income is sufficient to make all payments under the loan and to meet basic living expenses during the shorter of the term of the loan or the period ending 45 days after loan consummation;
  • “Reasonable” projections of amount and timing of the borrower’s net income, debt payments, housing expenses, and child support;
  • A determination if a borrower had a short-term covered loan or balloon payment loan paid off within the prior 30 days;
  • A determination if the borrower has expressed an inability to make a payment on an existing loan;
  • A demonstration that the borrower’s circumstances have recently improved if there is a presumption of unaffordability; and
  • The use of a CFPB-registered information system to report and obtain credit information about covered loans. This requirement includes the duty to report basic loan information and updates to that information.

 

  • The borrower’s current or reasonably expected income or assets (excluding the property that secures the loan) that the borrower will rely on to repay the loan;
  • The borrower’s current verified employment status and income;
  • Any payments on simultaneous loans that are secured by the same property (for example, second mortgages);
  • Ongoing expenses related to the mortgage loan or the property (such as property taxes, insurance, Home Owner Association dues, and ground rent);
  • Other debt obligations (such as alimony and child support payments);
  • The borrower’s monthly debt-to-income ratio or residual income; and
  • The borrower’s verified credit history.

 

 

The similarities in the required underwriting for these two vastly different types of lending represents a fundamental disconnect by the Bureau.  While CBA supports establishing clear criteria regarding the qualification and eligibility of borrowers of small-dollar credit products, the proposed level of underwriting complexity ignores the cost of providing this type of loan.  Requiring mortgage-like underwriting will only result in pricing out would-be providers.  CBA conducted an informal survey of member banks to ascertain an approximate cost of underwriting under the proposed provision.  Despite the fact that the vagueness of the ability to pay requirement makes it difficult to provide actual costs, we estimate that a loan made under the full-payment test would outweigh any return.   Banks will incur underwriting costs on all applications regardless of whether the loan is ultimately approved.  These costs will have to be absorbed into the pricing of approved loans, making most, if not all, loss leaders and unsustainable.

 

The Bureau also greatly underestimates the difficulties and impracticality of verifying “major financial obligations” of borrowers, such as rent payments (particularly for customers who share rental payments) or child support obligations.  Lenders will also have initial difficulties in obtaining reliable information on a consumer’s borrowing history for other covered loans, because credit reports currently do not indicate what is and is not a covered loan.

 

To complicate matters further, the Bureau has not made any clear indications of what would constitute a “reasonable” determination of ability to repay under the Proposal.  The Proposal currently provides that a covered lender’s ability to repay analysis must, at a minimum, forecast reasonable estimates of basic living expenses, projected income, debt obligations, and housing costs.  The Proposal also requires lenders to make reasonable inferences and conclusions regarding a borrower’s ability to repay, but it provides no safe harbor for covered lenders.  The absence of a safe harbor leaves open the possibility that the decisions of lenders would still be subject to scrutiny on the grounds that they are not “reasonable” even if those lenders analyze all the requisite information in the Proposal.  This risk seems particularly acute given that the Proposal does not provide examples of what it means to create “reasonable estimates” of basic living expenses, what constitutes “reasonable inferences and conclusions” regarding a borrower’s ability to repay, or what it means to “appropriately account” for information known by the lender.[15]

 

The required provisions would also add substantial burdens for consumers.  Consumers would need to spend significant time discerning and compiling the documentation required to provide to a lender.  The Bureau is failing to take into consideration that the information that is not readily available would have to be retrieved, while consumers’ need for small-dollar loans is often immediate.  Loans are needed to cover emergency repairs and medical costs.  They are needed to cover all-too-common fluctuations in income and to provide food for the family or gas to get to work.  Clearly, consumers cannot wait hours, certainly not days, for an underwriting decision. 

 

The Bureau estimates that the required ability to repay determination would take essentially no time for a fully automated electronic system and between 15 and 20 minutes for a fully manual system.[16]  It is unclear how the Bureau is making this calculation, which we believe grossly underestimates the time that would be needed to underwrite a small-dollar loan according to the mandated ability to repay analysis.  The similar calculation required for residential mortgages is a prime example of the complicated process involved in making an underwriting determination.  Appendix Q to Regulation Z, which sets forth the specific standards for lenders to determine mortgage applicants’ monthly debts and income, provides ample evidence of the complexity of determining and verifying income and expenses, including part-time and seasonal employment, bonuses and commissions, self-employment, alimony, and child support income.[17]  Small dollar borrowers need money quickly and would not be afforded the same leisurely timeframe as a mortgage borrower.  .

 

The Bureau has also stated that it believes that many lenders use automated systems when underwriting loans and would modify those systems, or purchase upgrades to those systems, to incorporate many of the procedural requirements of the full payment approach.[18]  This is simply not the case.  The full-payment analysis would mandate a nearly complete manual process for underwriting covered loans, a process that will require time and additional resources to implement.  For example, many processes that the CFPB indicates are automated, are in fact not necessarily the product of complex computer systems or algorithms, but instead are based on existing customer information such as deposit history and account utilization.  As a result, these systems provide scalability, reliable income, and expedited verification, but simply cannot be retooled to complete a formal underwriting as the Proposal would require.  CBA member banks estimate the ability to repay analysis as proposed could take up to a week or more to complete depending on the borrower’s access to required documentation and ability to find time to gather documents and provide them to the lender. Additionally, this process will have significant systems costs, in addition to further compliance and supervisory costs to ensure that the automated systems required by the Proposal work as intended.

 

  1. All-In APR

 

For longer-term loans, the Bureau has set an all-in APR threshold of 36%.  We urge the Bureau to abandon this approach, and instead, look to currently implemented regulations.  Other major federal lending regulations (e.g. Regulation Z) do not require calculation of APR on an “all-in” basis (defined to include interest as well as charges for credit insurance, ancillary products, Regulation Z finance charges, application fees, and fees for participation in any plan or any arrangement for a covered loan).  Imposing an all-in APR creates functionality issues, while standardizing an APR calculation will help avoid the expense of programming a new calculation and will assist in easing consumer confusion.

 

Additionally, 36% is artificially too low and will add little value to borrowers because lenders will not be able to meet this unrealistic metric.   For example, the cost to a consumer of 36% vs. 42% is not significant in small dollar, but could mean the difference between viable and unviable on a portfolio level.

 

  1. Frequency and Timing of Covered Loans

 

The Proposal imposes restrictions on rollovers, loan sequences, and refinancing by preventing the offering of short-term loans fewer than 30 days after payoff without a showing that the borrower’s financial situation is materially improved (and capping successive short-term loans at three before requiring a 30-day cooling off period), and preventing the refinancing of longer-term loans without a showing that payments would be smaller or would lower the total cost of credit. 

 

This approach undermines the nature of small-dollar lending and will likely have negative consequences for consumers.  Small-dollar products are designed to provide value of quick, immediate access to the exact amount needed (e.g. $100 to help pay a bill that is coming due and avoid the risk it will result in a late payment fee).  If a customer can only access a loan product with limitations on frequency, that customer will likely take a larger amount than is needed “just in case,” which will result in higher costs overall.  Moreover, consumers often do not experience liquidity shortages on a preset schedule so these needs are often unanticipated and require a quick remedy.  Liquidity shortages are often unpredictable (e.g. an unexpected car repair) and do not occur within periodic intervals. 

 

Further, the “cooling off” requirement would, for the first time, prevent a bank from providing credit to a consumer who would otherwise qualify for the loan and who has previously repaid existing loans. If every loan – including repeat loans – requires a full ability to repay assessment, the cooling off period would be unnecessary.  Clearly, if the borrower has repaid his loan, an institution would have no reason to classify him as a risky borrower and it would be appropriate to convey another loan to him.  If a bank determines at any point in time a borrower is unable to repay the loan, the bank would decline the application.  The proposed cooling off requirements create a different experience for consumers utilizing covered loans as opposed to other forms of unsecured lending.  We strongly believe these restrictive frequency limitations deny the majority of consumers’ to fulfill their small-dollar needs and represents a dramatic escalation in regulatory authority limiting qualified consumers to access to credit. 

 

Additionally, CBA believes the Proposal will not address the issue of repeat use that the Bureau is attempting to solve.  If a consumer has a short-term liquidity need and is unable to access funds, they will turn to other sources of short-term liquidity, such as pawn shops or overseas lenders, until they are again able to access covered loans.  These consumers will face other burdens such as overdrafting their account, delaying payments that could result in late fees and detrimental hits to their credit score, or forgoing needed non-discretionary expenses.    

 

We believe any frequency restrictions should be based on sustained use and not arbitrary utilization limits, especially when consumers pay back loans as agreed.  As an alternative approach to mandatory cooling off periods, the Bureau could include a provision in its final rule to ensure lenders of covered loans provide an “off ramp” to borrowers who demonstrate an inability to repay a loan according to its terms.  Trouble borrowers could be provided with mandatory disclosure alerting them to the availability of an installment option.  Furthermore, these borrowers could be prohibited from re-borrowing until the loan is paid in full. 
 

  1. Conditional Exemptions to Ability to Repay Determination

 

The Proposal does allow for a lender to avoid the overly restrictive underwriting analysis if they chose; however, these alternative methods call for restrictive, complex and prescriptive provisions that do little to provide banks with clear standards.  While our members would assert it would be helpful to utilize safe harbors to avoid the unrealistic underwriting requirements, the safe harbors as written will garner little interest due to strict usage constraints that will inhibit the ease of consumer use. 

 

  1. Short-Term Conditional Exemption

 

Under the short-term conditional exemption, referred to as the “principal payoff option,” consumers would be able to borrow up to $500 through a short-term loan, provided the loan does not include a security interest in a vehicle.  The lender could extend the loan only two times, provided the principal is reduced by one-third each time.  The lender would be prevented from extending the loan if it would result in the consumer having more than six covered short-term loans over the most recent 12 consecutive months.[19]  These loans are also subject to loan sequencing requirements that mandate second and third loans made within 30 days of a prior loan would be subject to tapering provisions - the second loan must be one third less than original and the third loan must be two thirds less than original.   Lenders would be required to impose a mandatory 30-day cooling period after a loan sequence. 

 

Similar to the reasons cited earlier regarding the full-payment option, CBA does not believe the principal payoff option will meet consumer expectations due to usage restrictions and unrealistically low dollar borrowing limits.  While the option removes much of the onerous ability to repay analysis requirements, the option will greatly constrain functionality of covered loans and create risk assumptions that banks are unwilling to assume.

 

Placing limits on frequency and timing of use will not serve consumer needs.  Again, consumer need for emergency liquidity is often irregular.  We assert limiting use frequency to a specific number for limited time will force consumers to borrow at amounts larger than needed resulting in higher overall costs.  Consumers should not be subject to restrictions if they remain current and repay a loan according to its terms.  Imposing the proposed limitations will only frustrate borrowers, pushing them to seek liquidity elsewhere to meet their immediate needs.  If consumers do show an inability to repay, they should be provided with an off ramp as previously discussed under the full-payment option. 

 

Unexpected expenses come in many forms and dollar amounts.  Those of us who have been confronted with an unanticipated medical or car expense are acutely aware the maximum loan amount of $500 will not meet many borrowers’ needs.  For example, an unexpected car repair, furnace and air conditioning repair, or emergency dental root canal will often exceed the allowable limits under this option.  This is not to mention emergency or unanticipated medication expense that can require thousands upon thousands in the blink of an eye. Out of sheer necessity, borrower will seek alternatives when their needs are unmet. Unfortunately, even if the supply goes away, the demand does not.

 

Further, the definition of small-dollar credit with loan amounts capped at $500 is incongruent with analogous state laws related to small-dollar credit products. For example, in the state of Alabama, small-dollar loans are defined as any loan under $2000.  This discrepancy will cause compliance problems for institutions that have mandates in place for higher small-dollar lending thresholds and could lead institutions to wind down products that customers currently use in order to comply with the CFPB’s new mandate of $500. 

 

Experience with Deposit Advance Products affords other data that shows the $500 threshold is too low to be meaningful for consumers.  For example, one institution reported that borrowers utilizing Deposit Advance Products averaged a per use draw of $235, but, those same customers routinely utilized three draws per cycle on average.  As a result, the total aggregate loan amount for a customer that was meeting their needs through the Deposit Advance Program was nearly $800 per cycle.  By instituting a cap at $500, the Proposal risks limiting customers’ access to valuable short-term credit they need and are able to repay.

 

Additionally, the Proposal would require lenders making a covered short-term loan under this option to determine if the borrower has had an outstanding loan in the past 30 days that was either a standard covered short-term loan or a covered longer-term balloon payment loan.  A lender could only make a loan under the principal payoff option if the loan would result in the consumer having a loan sequence of more than three covered short term loans by any lender.  Accordingly, these requirements apply regardless of whether any or all of the loans are made by unaffiliated lenders.[20]  As a practical matter, these provisions would be difficult to comply with and most lenders will not assume the risk associated with making a covered loan.  The duty to check for outstanding loans from unaffiliated lenders would require a lender to obtain the necessary information from a registered information system or directly from the borrower.  Direct reporting from a borrower would likely prove unreliable.  Checking a specified database would also likely be unreliable as some lenders will not comply with the reporting requirements and others will not report in real-time as it is common industry practice for creditors to batch credit reporting in cycles (e.g. once every 30 days).  As such, a covered loan made by an unaffiliated lender may be undetectable, creating unacceptable compliance risk for lenders.  A workable solution to this problem would be to provide a safe harbor for lenders who make the requisite checks on a customer by searching that borrower’s history with the individual institution, as opposed to requiring a database check at either a government agency or a third-party vendor.  History has shown government databases to be rife with inaccuracies that could unduly limit a customer’s access to necessary credit.  Further, a third-party database solution will undoubtedly raise the cost of the product for borrowers.[21]

 

Lastly, the proposed rules would be extraordinarily complex to manage from a communication/disclosure and adverse action perspective.  For example, if a customer had used only two non-consecutive loans in a twelve month period, but due to the monthly pay schedule accruing 64 days in debt, a bank could not in theory allow them to take a third loan more than 30 days ahead of their next paycheck, but the bank could allow the borrower to take one 10 days before.  It is unclear how banks would communicate these types of situations as a possible adverse action event and seems extremely unlikely that a customer would be able to clearly understand availability.

 

  1. Long-Term Conditional Exemptions

 

The Proposal includes some limited exceptions for longer term loans, giving lenders two options to avoid the full-payment test.  Under the first option, lenders would be allowed to offer loans that meet the National Credit Union Administration’s (“NCUA”) “payday alternative loan” (“PAL”) criteria of capping interest rates at 28 percent with an application fee of not more than $20.[22]  Under a second option, lenders could offer loans payable in equal installments with a term not to exceed 24 months as long as the lender’s projected rate of default on the loans was five percent or less.  However, if the lender’s default rate exceeded five percent in a given year, the lender would be required to refund its origination fees for its entire portfolio.[23] 

 

As is the case with the proposed short-term conditional exemption, the alternatives offered for longer-term loans fail to provide banks with a sustainable model.  We discuss each in turn. 

 

  1. NCUA PAL Model

 

Under the Proposal, the Bureau would specifically exempt loans modeled after the NCUA PAL program.  This exemption would permit credit unions to offer loans with terms of no more than six months where the principal of the loan is not less than $200 and not more than $1,000.   Loans must have an interest rate of no more than 28 percent allowing a $20 application fee.  Loans must be repayable in two or more payments due no less frequently than monthly, all of which payments are substantially equal in amount and fall due in substantially equal intervals.  The loan must amortize completely during the term of the loan and the payment schedule must provide for the allocation of a consumer’s payments to the outstanding principal and interest and fees as they accrue only by applying a fixed periodic rate of interest to the outstanding balance of the unpaid loan principal every repayment period for the term of the loan.

 

As a primary issue, banks are not tax-exempt institutions and, as such, have a diminished ability to make sustainable loans under the PAL model.  Tax-exempt status gives credit unions the flexibility needed to sustain a loan of this structure.  However, even with this immense benefit, existing PAL loans are often made at little to no profit by credit unions.[24]  Thus, banks that not afforded a similar tax status would be unable to operate within the proposed PAL exemption. 

 

Additionally, very few credit unions see the PAL program, even in its current structure, as a useful tool for meeting small-dollar needs.  According to the Bureau, less than 20 percent of credit unions offer PAL loans.[25]  This is a low number to begin with, but we believe the actual number to be lower.  According to the Credit Union National Association (“CUNA”), only one in seven credit unions currently participate in the PAL program – a mere 14 percent.[26]     

 

More importantly, the Bureau seems to believe the proposed inclusion of the PAL model provides for an outright exemption that preserves the integrity of the program.  However, we believe the added compliance complexity provided for in the Proposal will only serve to eliminate this already marginal product.  Among other things, the Proposal includes new requirements for the verification of income, and adds several other modifications to the PAL program including a change from a minimal loan of 30 days to 45 days, limitations on payment transfers, amortization and debt collection requirements.  These additional and significant compliance hurdles will make it nearly impossible for even tax-exempt institutions to make PAL loans, let alone taxed banks.

 

  1. Portfolio Default Rate Option

 

Under the second proposed longer-term exemption option, the portfolio loan exemption, lenders could offer a loan based on a duration of 46 days to 24 months, a modified total cost of credit of less than or equal to an annual rate of 36 percent with no more than a $50 origination fee, and a projected default rate of less than five percent.[27]  In addition, lenders would not be able to extend a longer-term conditional loan if, after a review of the lender’s records and the records of affiliates, the lender determines that the new loan would result in a consumer being in debt on more than two loans made with conditional exemptions.[28]

 

The portfolio loan exemption presents two important challenges for banks seeking to avoid the complex full-payment analysis.   First, lenders will have difficulty making loans at 36 percent or lower, especially at an all-in APR.  This low percentage ignores the cost of producing short-term credit.  We encourage the Bureau examine examples of all past small-dollar loan programs such as the Federal Deposit Insurance Corporation’s (FDIC) Small-Dollar Pilot Program and the NCUA PAL program and report on viability and customer outcomes for these products.  The Bureau has already completed a similar examination of payday loans and we believe it would be helpful for the Bureau to understand limitations and lack of viability of these products.

 

Second, the Proposal would require lenders that have a default rate exceeding five percent to refund origination fees for its entire portfolio for each year that it exceeded that threshold.  As a practical matter, some default is inevitable no matter how well underwritten a loan is.  This fact coupled with the draconian consequences for exceeding the seeming low five percent default rate on the entire portfolio, lenders will not be willing to assume this risk.  Banks are unsure that prudential regulators would view this option as a safe and sound lending practice because in times of elevated credit losses, the bank would be required to refund fees to consumers and place further stress on the bank’s loan loss reserves.  We urge the Bureau to get feedback from the prudential regulators on this portion of the Proposal, along with other sections.

 

It is useful to make a comparison of default rates for other types of short-term lending (e.g. credit cards) to understand why banks would hesitate to assume the risk associated with this provision.  The New York Federal Reserve Bank recently measured credit card delinquencies by looking at the percent of balances that are at least 90 days late (a prime indicator of default).[29]  For the first quarter of 2015, the rate for credit cards was 8.38 percent.  Accordingly, we believe even normal default rates would exceed the five percent threshold, creating little incentive to utilize this exemption option. 

 

  1. Additional Concerns

 

In addition to the above-referenced issues, the Proposal presents a number of compliance complexities that we believe will be difficult to implement and will certainly add to the cost and limit the availability of products to consumers.  We discuss each in turn.

 

  1. Credit Information Furnishing

 

Under the Proposal, lenders would be required to use CFPB-registered information systems to report and obtain credit information about covered loans.  This requirement includes the duty to report basic loan information and updates to that information.  The registered information systems will have to be created by companies that will provide this service once the rule is finalized.  The Bureau indicated it will publish a list of registered systems.  Lenders must provide basic information about the loans and the borrower at the time of origination, updates during the life of the loan, and additional information when the loan period ceases.  The lenders must also solicit and review a consumer report about the borrower from a registered information system before making the loan.  The registered information systems themselves must meet certain eligibility requirements related primarily to their reporting capabilities and performance. [30]

 

These provisions add complexities that will frustrate small-dollar offerings and this requirement alone could increase the cost of these small-dollar products to the point they become unprofitable for banks.  First, pulling a credit report for every covered loan has potentially negative effects on consumers’ credit scores.  Hard credit inquiries, inquiries where a potential lender is reviewing a borrower’s credit due to an application for credit, can affect a borrower’s credit score for a number of reasons – frequency of inquiries, number of open loans, and time since recent account openings or other inquires for credit.  Inquiries can have a great impact if a borrower has few accounts or a short credit history.  Under the Proposal, banks would need to make credit report inquiries to ensure a customer continues to have the ability to repay all loans made.  This process of making multiple inquiries could have a detrimental effect on one’s credit score and, in turn, would cause, not prevent, harm to the customer by possibly limiting access to other forms of credit. 

 

Second, the time needed to pull and review a borrower’s credit report and the expense associated with the credit pull will reduce the convenience of covered loans and add to their overall costs.  As previously commented, consumers in need of emergency small-dollar loans often do not have the luxury of time.  Waiting on a review of their credit report and other relevant materials will greatly increase the time needed to underwrite covered loans.

 

  1. Record Retention Requirement

 

Lenders must establish and follow a compliance program and retain certain records, such as the initial loan agreement, documentation obtained for a covered loan, and calculations surrounding presumptions of unaffordability.[31]  The ambiguities contained in the Proposal, along with its complexities, would create a situation where the system’s requirements to effectively manage the small-dollar products would be a significant cost.  Unfortunately, these same ambiguities make it difficult to project an actual system’s cost because the bidding process would include too many unknowns.  However, we are comfortable in estimating that if the rule is finalized as written, it would take, at the very least, one full year to research and scope a possible product set and system resources necessary to comply with the Proposal.  If the product development survived this timeframe, it would take a significant implementation timeframe for the bank to bring a product to market and test it.  As a result, the complexity of the Proposal threatens to limit the availability of small-dollar credit in the implementation period given the difficulties in researching, designing, testing, marketing, and implementing any new, or retooling any existing, small-dollar lending platform. 

 

  1. Pull Attempts and Written Notice of Pull

 

The Proposal addresses payment transfers in connection with covered loans.  Specifically, the Proposal would make it an unfair or abusive act or practice for a lender to attempt to withdraw payment from a consumer’s account in connection with a covered loan after the lender’s second consecutive attempt to withdraw payment from the account has failed due to a lack of sufficient funds, unless the lender obtains the consumer’s new and specific authorization to make further withdrawals from the account.[32]  This applies to electronic fund transfers (“EFT”), signature checks, remotely created checks, remotely created payment order, and an account-holding institutions transfer of funds from a consumer’s account that is held at the same institution.[33] 

 

As support for its proposed provisions, the Bureau has relied on its own report entitled “Online Payday Loan Payments,” which summarizes data on return rates of ACH payments made by bank customers to repay certain online payday loans.[34]  In the report, the Bureau cites three principal findings:

 

  • Half of online borrowers are charged an average of $185 in bank penalties;
  • One third of online borrowers hit with a bank penalty wind up losing their accounts; and
  • Repeated debit attempts typically fail to collect money from the consumer.

 

However, it is important to note that the data used in the report was from a 2011 to 2012 sample period and fails to take into consideration important developments in payment processing since that time.  Most notably, the re-submissions contemplated by the proposed provisions are largely addressed in current rules developed by the National Automated Clearing House Association (“NACHA”).

 

The NACHA Operating Rules restrict lenders from making more than three attempts to collect a single payment via the ACH system. [35]  These rules already allow for returned entries to be reinitiated by the originator (“ODFI”) under the following limited circumstances:

 

  • An ACH debit was returned for reasons of insufficient or uncollected funds. In such a case, the entry may be reinitiated a maximum of two times in an attempt to collect funds;
  • An ACH debit was returned for the reason of stop payment, and reinitiation has been separately authorized by the receiver;
  • An ACH entry was returned for another reason, and the ODFI has corrected or remedied the reason for the return.

 

Additional restrictions, however slight, will require banks to redesign existing systems to conform to the proposed provisions.  Despite the recent enactment, NACHA will also have to change their rules to accommodate the requirements under the Proposal.  Implementing these provisions will come at a cost to banks and their customers.  We believe the difference of one allowable pull attempt hardly justifies the cost of this process change, especially since the data relied on fails to take NACHA changes into account.  Again, the report relied on for this proposed structure, “Online Payday Loan Payments,” is not only untimely, but it focuses largely on the behavior of non-depository payday lenders.  Since bank lenders have access to the consumer’s deposit account, they would have the ability to stop a withdrawal based on lack of funds availability, or to avoid charging a fee should a payment take their account into negative status.  For these reasons, we urge the Bureau to conform its provisions to current practices.

 

The Proposal also would require lenders to provide consumers with certain disclosures regarding upcoming withdrawals and withdrawals with a varying payment amount, a date other than the regularly scheduled date, or differing payment channel.[36]  This convoluted process of disclosure and presentment will add extreme complexity to compliance with the proposed provision, increasing the inability for banks to make small-dollar loans to consumers in need. 

 

  1. Anti-Evasion

 

The Dodd-Frank Act authorizes the Bureau to prescribe rules “as may be necessary or appropriate to enable the Bureau to administer and carry out the purposes and objectives of the Federal consumer financial laws, and to prevent evasions thereof.”[37]  The Bureau has relied on this authority for several elements of the Proposal, including an anti-evasion clause.  In determining whether a person is evading the requirements of the rule, the Bureau indicated it would consider whether all relevant facts and circumstances reveal “the presence of a purpose that is not a legitimate business purpose.”[38]

 

According to the Proposal, the CFPB will take into consideration the actual substance of the lender's action as well as "other relevant facts and circumstances" to determine if the lender's action was taken with the intent of evading the requirements of the Proposal. The Bureau states such evasive action can be knowing or reckless.  The Bureau acknowledges that it cannot anticipate every possible way in which lenders could evade the requirements of the Proposal, but it does provide a short, non-exclusive list of actions that might indicate such intent.  These include various fee structures as well as methods of changing the nature of a loan after consummation.

 

We firmly believe the inclusion of an anti-evasion clause creates a risk that will chill the participation of depositories in the small-dollar market.  The language, "other relevant facts and circumstances," is incredibly vague and fails to provide compliance-minded institutions with much needed clarity.  Without bright line rules for compliance, banks will be wary of producing products that could be misconstrued as evasive and, therefore, consumers will be denied the benefit of many quality credit options.  We urge the Bureau to eliminate the anti-evasion provisions contemplated in the Proposal and provide lenders with clear, easy to follow guidelines to ensure compliance.

  1. Unintended Products Coverage

 

The Bureau has proposed several exclusions from the definition of covered loans including loans intended to finance the purchase of a car or goods where the goods secure the loan, mortgages and loans secured by real property, credit cards, student loans, non-recourse pawn loans, and overdraft services/protection.[39]  CBA supports these exemptions and believes they will allow banks to offer everyday products without disruption. 

 

However, the Proposal raises troubling issues regarding the impact on some traditional bank products, as the stringent all-in APR can encompass many bank products under the covered loan umbrella, including subprime auto title loans and subprime installment loans.  This will impact the ability of lenders to offer some traditional loans to those individuals whose FICO scores do not entitle them to a loan at an interest rate below 36 percent.  Additionally, the inability to utilize lines of credit will impact the ability of state-chartered banks with lower usury caps that will be unable to offer products because of the restriction on the credit line.

 

Specifically, under the Proposal, all longer-term loans without a limitation on term are covered loans if they carry an interest rate greater than 36 percent.  For example, a ten-year loan with an ACH debit feature at a 37 percent interest rate would fall under the scope of the proposed rule as a covered loan.  Also, although the Proposal specifically excludes from coverage “credit extended for the sole and express purpose of financing a consumer’s initial purchase of a good when the credit is secured by the property being purchased, whether or not the security interest is perfected or recorded,” this exemption would only apply to financing that is specifically “for the sole and express purpose of financing a consumer’s initial purchase of a good.”[40]  In auto finance, the “good” the Proposal refers to is the vehicle, but it is rare that an auto finance transaction fund only the cost of the vehicle, and instead often includes fees, taxes, and ancillary products.  We are concerned the language of the exclusion suggests the exemption would not apply to a transaction if it were to include any ancillary products financed on a single contract.  For example, if the consumer’s loan includes tax, delivery, expedited service, a warranty, a service plan, etc., it is not clear whether the loan would be covered or not.   We believe that just because the consumer finances something directly related to the purchase should not cause the loan to be included under the Proposal.  If the Bureau intended to address “cash out” opportunities with respect to the loan, or no financing of debt cancellation, etc., that should be addressed directly and the inclusion of routine costs in the loan amount should not be what causes a loan to be covered by the rule.  Otherwise, any purchase-money vehicle financing with a “total cost of credit” in excess of 36 percent would be classified a covered loan and the lender would be deterred from offering products customers desire as part of the contract.

 

The Bureau appears to recognize this point in the corresponding Request for Information (“RFI”) where it notes on multiple occasions that consumers face additional risks on account of disability, illness, loss of employment, family disruptions such as divorce or separation, and many other unexpected expenses.[41]  Lenders of conventional installment loans and auto dealers help solve this problem by offering additional products that cover these various risks.  As drafted, the Proposal may lead to consumers having restricted access to valuable products.   

 

Additionally, it is unclear if non-credit related features would bring a loan within the scope of the Proposal.  For example, a lender may make a loan that complies with the guidelines and falls at or below the all-in APR of 36 percent when calculating all credit-related features.  However, should the borrower decide to utilize an optional service such as a funds transfer fee (a non-credit related feature), that, if included in the calculation, could push the all-in APR above 36 percent.  It is unclear if this example would be considered a violation of the Proposal.  Non-credit related features can add to the ease of borrowing for consumers.  To effectively eliminate them by including them in the all-in APR would be a disservice to many consumers.  Accordingly, should the Bureau move forward with an all-in APR calculation, we urge it to specify that only credit-related features, those that are directly related to the transaction as they are necessary for the transaction, should be included in the calculation.  All unrelated products, those that are not directly related to the transaction, such as ancillary products, fees, and taxes, should not be included in the calculation. 

 

  1. Foreign Language Disclosures

 

The Proposal would allow lenders to provide the disclosures required by proposed section 1041.7(e) in a foreign language, provided that the disclosures must be made available in English upon the consumer’s request. The Bureau believes that, if a lender offers or services covered loans to a group of consumers in a foreign language, the lender should, at least, be allowed to provide disclosures that would be required under proposed section 1041.7(e) to those consumers in that language, so long as the lender also makes an English-language version available upon request from the consumer.[42]

 

The Bureau seeks comment in general on this foreign language requirement, including whether lenders should be required to obtain written consumer consent before providing the disclosures in this section in a language other than English and whether lenders should be required to provide the disclosure in English along with the foreign language disclosure. The Bureau also seeks comment on whether there are any circumstances in which lenders should be required to provide the disclosures in a foreign language and, if so, what circumstance should trigger such a requirement.[43]

 

CBA strongly believes, because this is an issue that impacts many different consumer disclosures, it is more appropriate for the Bureau to consider limited English proficiency issues in a separate comment process.  Our lenders want to communicate with every customer in the language she prefers, however, that practice is not realistic, especially with the UDAAP concerns.  Moreover, current market incentives encourage lenders to communicate effectively with their borrowers, but we oppose new requirements to issue legal documents, including disclosures, in other languages as they would have wide ranging consequences that deserve more thoughtful consideration than can be provided in this context of this already large rulemaking.  We welcome the opportunity to work with the Bureau on this issue going forward.

 

  1. Payment to Income Ratio Alternative

 

In the outline of provisions under consideration during its Small Business Regulatory Enforcement Fairness Act panel process (“SBREFA”), the Bureau included an exemption to the ability to repay analysis for longer‐term loans of up to six months, so long as the loan’s payments did not exceed five percent of a borrower’s gross income – the payment to income test (PTI).[44]   Although the Bureau did not include this exemption in the Proposal, it has requested comment on the provision nonetheless.[45]  CBA believes that, conceptually, the approach outlined under PTI offers a more feasible approach that may enable depositories to make small-dollar loans.  Unlike the previously discussed ability to repay options and the proposed alternatives, the payment to income test provides for streamlined, easily applied criteria that enable lenders to avoid incurring substantial underwriting costs and provides an avenue for banks to offer small-dollar loans at much lower prices than many non-depository lenders.  A simplified approach free of burdensome underwriting, ancillary compliance mandates and unreasonable limits on product utilization appears to be the only clear path to CBA member banks entering the small-dollar market in any significant manner.   

 

However, while we support the PTI approach for its simplicity and functionality that will allow for scalability of systems, we believe the suggested ratio should be variable and not simply limited to just five percent.  While some institutions may be able to scale a product to fit within the five percent PTI, we believe this ratio may be artificially low and will not produce products that are sustainable for many banks and that will fit most consumers’ needs.  Recent research indicates there is cause for concern with a limited PTI ratio ceiling.  In a 2015 study, Navigant examined 1.02 million installment loans and found PTI ratio limits pose substantial risks of reduction in overall credit availability to the small-dollar credit population.[46]  Specifically, the study found that a five percent PTI ratio limit would limit access to credit for 86 percent of current borrowers, with only 14 percent having a PTI ratio of less than five percent.  The study also found PTI ratios to be poor metrics for predicting loan repayment and that those who borrow repeatedly are more likely to repay their loans on average and that slight reductions in default rates resulting from a low PTI ratio limit are more than offset by the resulting reduction in credit access.

 

Another study analyzed 87 million loans and found no correlation between individual consumer defaults and specific PTI ratios, suggesting that PTI may not be useful in limiting default.  In addition, as indicated by the Navigant study, the other study found that low PTI ratios could greatly limit access to credit to those in need.[47]

 

            However, the idea of a floating point PTI ratio that is above five percent may provide the flexibility necessary to allow more banks to enter the small-dollar lending market, provided that PTI ratio is left as a guidepost for the banks to determine whether it is the proper amount based upon the banks experience with the customer and their applicable risk thresholds subject to prudential supervisory oversight.  Accordingly, CBA urges the Bureau to revisit the concept of employing the streamlined approach taken under the PTI test and conduct further analysis on a PTI ratio that would provide for consumer needs and product sustainability. 

 

  1. A Practical Approach

 

CBA believes a product modeled after bank-offered Deposit Advance Products, coupled with a reasonable PTI ratio, would allow for low-cost, affordable products that provide consumers with enhanced protections and banks with viable product offerings.    

 

This model could be offered at much lower rates than non-bank alternatives.  By incorporating realistic underwriting standards to determine eligibility and loan/line amounts, banks could create products with low underwriting costs.  For example, deposit account attributes such as deposit amounts, cash flows, and tenure provide a very solid proxy to Bureau’s rigorous underwriting standards at a fraction of the cost and allows banks to serve more consumers in need.  This approach could also incorporate reasonable cooling off periods that are tied to sustained use (e.g. more than three months), not the number of times a product is used.  Once a customer hits a certain amount of months used, banks could convert them to a term loan which serves as both a relief to the debt trap issue and a cooling period simultaneously.

 

Discussed in detail below, the attributes of bank Deposit Advance Products enhanced by an appropriate PDI will provide a solid foundation for depositories to enter the small-dollar market, enhance market competition, and, most importantly, provide robust consumer protections that will allow for ease of use and prevent sustained consumer reliance.    

 

  1. Bank Small-Dollar Lending

 

Traditional lenders are in a unique position to help those in need of short-term liquidity.    However, flexibility from regulators is key to encouraging development of small-dollar loan products by depositories.  While we applaud the Bureau’s intention to curb the abuses of bad lenders, unfortunately, we firmly believe the Proposal will also have the unintended effect of driving away consumer-friendly financial institutions that provide better alternatives.  Limiting the overly burdensome provisions of the Proposal will be an essential factor in determining whether banks and credit unions innovate and offer alternatives to payday loans.

 

Historically, the federal banking regulators have encouraged depository institutions to meet this particular consumer credit need.  In response to this growing need for short-term credit, and receiving encouragement from our prudential regulators to offer a small-dollar loan product, some banks developed Deposit Advance Products for consumers who could not qualify for traditional forms of credit.  For many years, these products successfully yielded positive reactions from regulators and demonstrated that close working relationships between banks and their regulators can result in services that meet consumers’ needs.  Additionally, deposit advance products were carefully designed to ensure strong safeguards at reasonable prices.

 

However, in late 2013, the Office of the Comptroller of the Currency (OCC)[48] and FDIC[49] separately finalized restrictive supervisory guidance on deposit advance products that left only one bank offering DAP services remaining in the market.[50]  While several reasons contributed to their exit from the market, the primary force was the supervisory guidance that was inconsistent with the structure and use of deposit advance products, which provide consumers immediate access to the exact amount of money needed.

 

For the many reasons discussed below, we urge the Bureau to reexamine the utility of bank-offered deposit advance products, and work closely with the other Federal regulators to develop consistent regulation and guidance that will allow banks to operate within clear standards in order to avoid regulatory conflict.

 

iii.                The Benefit of Deposit Advance Products

 

The media coverage of “payday lending products” incorrectly associates bank-offered deposit advance products with traditional payday lending, with little or no distinction in how bank-offered product features allow for greater consumer protection and better customer pricing. There appears to be widespread misunderstanding about how the products work and how consumers use them responsibly to manage their financial needs.  Additionally, many consumer groups have unjustifiably raised concerns over bank-offered deposit advance products. Similar to press accounts, these groups have likened the deposit advance products to non-depository payday lending and have all but ignored the significant positive features in product design and utility. 

 

However, there is little evidence of consumer dissatisfaction with bank-offered deposit advance products.  To the contrary, consumer satisfaction with these products is often very high with below average complaint rates.  For example, in one bank’s survey of deposit advance customers, 90 percent of respondents rated their overall experience with the product as “good” or “excellent.”  In another survey by a different bank, the customer satisfaction rating ranked higher for the bank’s deposit advance product than any other product offered by that bank.  Similarly, in yet another bank’s survey, more than 95 percent of customers said they were “satisfied” or “highly satisfied” with the product. 

 

Complaint levels for deposit advance products are extremely low across the board.  One bank that offered the product registered just 41 complaints over the course of a year, representing a mere .018 percent of all active users of that bank’s deposit advance product.  This percentage equates to roughly one in every 5,500 users.  Whether taken together or considered separately, the high customer satisfaction ratings and low levels of customer complaints for deposit advance products refute claims that these products pose significant reputational risk.   

 

There are significant differences between bank-offered deposit advance products and the services offered by non-depository lenders.  Bank-offered products have built-in controls designed to limit the usage of the product.  These controls include limits on loan amounts, automatic repayment through a linked depository account and “cooling” periods, all designed to keep customers from relying too heavily on the product and to ensure the customer’s ability to repay the loan.

 

Making Deposit Advance even more transparent and less risky, consumers who use bank-offered deposit advance products already have a relationship with the bank.  Deposit advance is an integrated feature added to the customer’s existing checking account and is not a stand-alone product, allowing banks to better understand a customer’s financial situation and ability to repay.  These services are only available to established customers who have maintained checking accounts in good standing with regularly scheduled direct deposits for a minimally prescribed period of time.  The maintenance of this relationship is of the utmost importance to a bank.  Without a positive banking experience, customers would look elsewhere to meet financial needs and banks would not only lose the opportunity to service the customer’s short-term liquidity needs, but also the chance to establish or maintain a long-term banking relationship.

 

Bank-offered deposit advance products offer customers greater account security.   With these products, customers do not have to provide sensitive bank information to third-party financial service providers, opening the door to the possible compromise of sensitive financial information.   Accordingly, all personal account information is kept in house, providing a significant security advantage to non-depository services.

 

The banking industry supports clear and conspicuous disclosures for all financial products and services that assist consumers in making informed decisions about managing their finances.  Banks that provide deposit advance products adhere to strict disclosure standards and all product terms are made clearly and fully transparent to customers prior to product use.  At a minimum, all deposit advance providers are bound by applicable federal laws and the customer is typically required to sign a separate, detailed terms and conditions document to activate a deposit advance line of credit.

 

All depository institutions that offered, or still offer, deposit advance products have limits on the amount a consumer may borrow.  Although it varies from bank to bank, advances are generally limited to the lesser of a specific amount or a percentage of the total amount of a customer’s monthly direct deposits.  These limits ensure that there is money available to the customer for other monthly expenses after the advance is paid.

 

Additionally, all bank-offered deposit advance products impose a mandatory cooling-off period to ensure customers do not depend on the product to meet their monthly financial needs.  These periods are imposed to ensure deposit advance products are used for the intended purpose, namely, short-term liquidity.  To manage the risk that the consumer will become reliant, a customer typically will be able to access a deposit advance product for a limited period of time at the end of which they would be required to repay the outstanding balance or completely stop using the product.

 

Deposit advance products have been criticized for their seemingly high costs when considering the relatively small size of the credit extended.  However, in order for any product to be sustainable, not to mention safe and sound, it must be delivered in a cost-effective manner for both the provider and the customer.  Previous small-dollar lending programs, such as one suggested by the FDIC,[51] have not been widely adopted by the industry because the costs to administer the programs outweigh the revenues and, hence, are not sustainable.

 

Furthermore, the expense of providing an open-end line of credit is nearly the same irrespective of the amount outstanding.  Most deposit advance products are priced based on a percentage of the amount advanced and do not include additional costs to the consumer such as application fees, annual fees, over-limit fees, rollover or re-write fees and late payment fees.

 

  1. Regulatory Coordination

 

Despite the many consumer protections and benefits built into bank-offered deposit advance products, the OCC and FDIC effectively forced the shutdown of the product that was designed to benefit consumers in need, forcing them into more costly alternatives.  CBA believes it is patently contrary to the intent of any regulatory action to force further monetary constraints on the consumers it intends to help.  Regulators should be working closely with industry on practical solutions in order to build a foundation to fully support small-dollar lending needs.  We believe this to be especially true for designing products and services that will allow the under-banked and unbanked greater access to mainstream banking opportunities.

 

Title X of the Dodd–Frank Act created the Bureau to specifically address issues of consumer protection surrounding financial products.  To ensure equal protections across all financial products and services, the Bureau’s authority to promulgate consumer protection rules extends to all providers of financial services and products including depository and non-depository institutions – authority that the prudential banking regulators do not have.  Accordingly, only the Bureau can ensure that consistent rules are applied across the entire financial services industry.  Unilateral actions by other Federal regulators are contrary to Congressional intent in creating the CFPB and directing that agency to regulate consumer financial services whether offered by banks or nonbanks.  Absent across-the-board standards, consumers will be pushed into services that offer fewer protections and come at significantly greater costs.  Indeed, even within the realm of Federal prudential banking supervision, banks of different charters will apply inconsistent standards with regards to deposit advance products. 

 

For many of CBA members, the existing OCC/FDIC supervisory guidance will present a roadblock for bank-offered products, regardless of a workable final rule for the Bureau.  We urge the Bureau to work closely with the Federal prudential banking regulators to ensure consistency across all institutions.

 

* * * * *

 

Banks are in a unique position to help millions of Americans that need small-dollar credit.  Banks are thoroughly supervised, amply regulated and well capitalized institutions in which U.S. consumers will find fair pricing coupled with established consumer protections.  However, the overly restrictive approach currently offered by the Bureau will only lead to less depository participation, pushing consumers into more unfavorable alternatives with higher costs and less oversight.  We urge the Bureau to reevaluate the Proposal and to work with all stakeholders to establish a rule that will not unnecessarily inhibit the ability of U.S. depositories to offer credit products that meet the short-term borrowing needs of their customers.  

 

CBA greatly appreciates the opportunity to share our suggestions and to work with the Bureau as it considers the regulation of small-dollar credit.  Should you need further information please do not hesitate to contact the undersigned directly at dpommerehn@consumerbankers.com

 

 

 

Sincerely,

dpommerehn

David Pommerehn

Vice President, Senior Counsel

Consumer Bankers Association

 

 

 

[1] The Consumer Bankers Association is the only national financial trade group focused exclusively on retail banking and personal financial services—banking services geared toward consumers and small businesses. As the recognized voice on retail banking issues, CBA provides leadership, education, research, and federal representation for its members. CBA members include the nation’s largest bank holding companies as well as regional and super-community banks that collectively hold two-thirds of the total assets of depository institutions. 

[2] Board of Governors of the Federal Reserve System - Report on the Economic Well-Being of U.S. Households in 2015 (May 2016)

[4] Center For Financial Services Innovation - Understanding and Improving Consumer Financial Health in America (March 2015)

[7] According to study conducted the Center for Financial Services Innovation entitled A Fundamental Need: Small-Dollar, Short-Term Credit (2008), continued market competition and product innovation would be advantageous in expanding small-dollar, short-term lending and may ultimately help lower the cost of these products for both providers and consumers.

[9] See, An Analysis of Consumer’s Use of Payday Loans, Gregory Elliehausen, Division of research and Statistics, Board of Governors of the Federal Reserve System (2009) – Survey results of consumer use of payday lending indicated that most customers used payday loans as a short-term source of financing.  Also see, Payday Lenders: Heroes or Villains? Adair Morse, University of Chicago (January 2007) - An assessment of the impact of payday lenders on disaster-struck communities concluded communities struck by natural disasters are more resilient and their community welfare improves as result of the availability of payday advances. Also see, Payday Holiday: How Households Fare after Payday Credit Bans. Donald P. Morgan and Michael R. Strain (2008) - An assessment of states with payday lending bans concluded that consumer financial problems saw significant increases when compared to states without similar restrictions.  Also see, Do Defaults on Payday Loans Matter?, Ronald Mann, Columbia Law School (2014)– Survey findings suggest default on a payday loan plays at most a small part in the overall timeline of the borrower’s financial distress.  Also see, Payday Loan Rollovers and Consumer Welfare, Jennifer Lewis Priestley, Kennesaw State University (2014) – Study found that borrowers with a higher number of rollovers experienced more positive changes in their credit scores than borrowers with fewer rollovers.

[10] 12 U.S.C. § 5517(o).

 

[11] 81 Fed. Reg. at 47864.

[12] Id.

[13] 81 Fed. Reg. at 47865.

[14] 12 CFR 1026.

[15] See Official Interpretation to Proposal Section 1041.5(b).

[16] 81 Fed. Reg. at 47939.

[18] 81 Fed. Reg. at 48117.

[19] 81 Fed. Reg. at 47973.

 

[20] Id at 48198 – 48199.

[21] The Bureau seeks comment on whether this particular provision for unaffiliated lenders should apply to all covered loans, not just those under the short-term conditional exemption.  We believe the above-referenced issues would apply to all loans covered by the Proposal.  

[22] 81 Fed. Reg. at  48035.

[23] Id at 43038.

[24] Credit Union National Association June 27th, 2016 letter to NCUA Chairman Rick Metsger outlining concerns over PAL exemption.

[25] 81 Fed. Reg. at 48031.

[27] 81 Fed. Reg. at 48038.

[28] Id at 48044.

[29] Federal Reserve Bank of New York Quarterly Report on Household Debt and Credit, May 2015.

[30] 81 Fed. Reg. at 48089.

[31] 81 Fed. Reg. at 47866.

[32] Id at 48175.

[33] Id at 48052.

[35] NACHA ACH Operations Bulletin #1-2014: Subsection 2.12.4 Reinitiation of Returned Entries.

[36] 81 Fed. Reg. at 48213.

[37] 12 U.S.C. § 5512(b)(1).

[38] 81 Fed. Reg. at 48112.

[39] 81 Fed. Reg. at  47864.

[40] Id at 47917.

[41] Request for Information on Payday Loans, Vehicle Title Loans, Installment Loans, and Open-End Lines of Credit, Dkt. No. CFPB-2016-0026, at 20 & 30 (June 1, 2016).

[42] 81 Fed. Reg. at 47984.

[43] Id at 43079 - emphasis added.

[44] Small Business Advisory Review Panel for Potential Rulemakings for Payday, Vehicle Title, and Similar Loans, Outline of Proposals under Consideration and Alternatives Considered (March 2015).

[45] Id at 48039.

[46] Navigant - Small-Dollar Installment Loans: An Empirical Analysis (March 2015).

[47] Peter Toth - Measures of Reduced Form Relationship Between the Payment-Income Ratio and the Default Probability (February 2015).

[48] OCC - Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products (November 2013): http://www.occ.treas.gov/news-issuances/federal-register/78fr70624.pdf .

[49] FDIC - Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products (November 2013): https://www.fdic.gov/news/news/press/2013/pr13105a.pdf .

[50] The remaining depository offering a deposit advance product is supervised by the Federal Reserve and not subject to guidance issued by the OCC or FDIC.

[51] FDIC – Small-Dollar Loan Pilot: https://www.fdic.gov/smalldollarloans/.