In 2017, the Consumer Financial Protection Bureau (CFPB) finalized a rule to combat so-called “payday debt traps.”
This week a new rule was finalized to reverse the protections, which were largely aimed at protecting people in precarious economic situations from being trapped in a vicious and costly cycle of astronomical interest rates – a phenomenon that particularly affects black communities.
In the meantime, the CFPB has announcement that next week is “Consumer Financial Protection Week”.
The 2017 rule required payday lenders – which provide short-term loans to people who need to cover their expenses until their payday – to Check to see if people who borrow money are able to repay it while still being able to meet “basic living expenses and major financial obligations”.
The rule, passed under then-CFPB director Richard Cordray, fell along a partisan divide. Consumer groups saw it as a triumph (or at least a bare minimum) and an essential protection against predatory financial practice.
The lucrative payday loan industry saw it as a threat, and Kathy Kraninger, the Trump appointee to head the agency, is now reversing a key provision of the original rule.
In credit markets, lenders typically check whether a borrower can afford to repay a loan before money is lent. Although the commercial payday lending group, the Community Financial Services Association of America’s best practices include “a reasonable and good faith effort to determine a customer’s creditworthiness and ability to repay the loan,” the group fought a requirement codified in the original rule that lenders must assess repayment capacity. CASA applauded the news that the CFPB was removing this requirement, noting that the CFPB “will ensure that essential credit continues to flow to communities”. Other groups like the Consumer Bankers Association echoed those sentiments.
The final rule, however, will preserve the limitations of the original rule on how payday lenders can withdraw funds directly from a borrower’s account. Under the rule, a lender will not be able to make more than two attempts to withdraw money from an account and will require written notice before making a first attempt.
Alan Kaplinsky, a partner at the Ballard Spahr law firm that works on consumer financial services issues, told Yahoo Finance that “the industry is largely happy with what it got.”
On the other hand, Ashley Harrington, director of federal advocacy and senior counsel for the Center for Responsible Lending, told Yahoo Finance that “predatory lenders often hide behind the idea that they provide access to credit.”
“Our belief is that access to credit with three-digit interest rates is not access to credit – it’s a debt trap,” she said. “They’re targeting communities of color and low-income people and putting them in this cycle of debt.”
In April, a career economist at the CFPB alleged that political appointees at the CFPB had manipulated research in order to justify changing the rule.
A huge step backwards for poverty alleviation efforts – and one that disproportionately affects black communities
In 2014, a CFPB study found that most payday loans were not short-term as many might hope. Four out of five loans ended up being renewed within 14 days, and 22% of them were renewed six or more times. Three in five consumers ended up paying more in fees (mostly interest) than the amount they borrowed for multiple loans, with one in five loans costing more in fees than the principal.
Although the industry touts payday loans as a lifeline for people in need of credit, the Bureau’s previous version concluded that they were ultimately harmful without the rule. the study did not examine demographics, but many experts and researchers have found that it affects black and other communities of color the most.
African Americans, a Bench study found, were 105% more likely than other groups to use payday loans, with 12% of African Americans having used them compared to the next group, “Hispanic”, which was 6%. According to New America, a think tank, the exclusionary practices of mainstream banks often contribute to “‘banking deserts’ in which payday lenders, check cashers and other non-banking services thrive.”
Jacob W. Faber, an associate professor of sociology and public service at NYU who studies inequality and the roles that financial institutions play, told Yahoo Finance that the practices of “alternative” providers are at the center of concern for advocates of the fight against poverty.
“Most people in this space consider payday loans to be the most predatory of alternative financial services because people tend to get trapped in these payday loan cycles,” Faber said. “Subprime loans are another form of financial exploitation.”
“Reverse redlining,” as some call it, reverses traditional redlining (not giving credit to black communities) by giving people high-interest loans that they may not be able to repay easily, trapping them in defaults, foreclosures, or multiple cycles of a payday loan.
The situation has also deteriorated with the coronavirus. A recent report by the Wall Street Journal showed that lenders have started targeting borrowers for loans with “three-digit interest rates” and are moving into areas hard hit by the coronavirus, despite advertising bans from Google and Facebook. (The companies deleted them when the Journal asked for comment.)
“Now is the worst possible time for regulators to allow predatory lending,” Harrington said. “We are in such difficult economic, social and political times and opening the doors to bad practices makes no sense.”
Harrington and the Center for Responsible Lending advocate a 36% cap on interest rates, which is currently the limit that can be charged to members of the army. In 2019, average payday loan the interest rate was 391%.
The consumer watchdog’s work on the rule is far from done, however. As has been the case with previous rulemaking, Kraninger’s version of the payday rule could be challenged in court, as well as on Capitol Hill.
While it’s possible a consumer advocacy group could take legal action against the CFPB, the biggest battle could unfold in the halls of Congress and at the White House. Democrats could defeat the final rule in two ways: overturn the rule through the Congressional Overhaul Act or, if Joe Biden wins the election, simply overturn the rule through a new CFPB chief.
Under the Congressional Review Act, a regulatory rule can be struck down if the House and Senate vote to “disapprove” it. A Democratic-led House could launch a challenge to the ARC, but a Republican majority in the Senate and veto power in the White House would make the effort virtually impossible at this time.
That means the clearest path to overturning the rule comes with a Biden election in November.
Isaac Boltansky, director of policy research at Compass Point, told Yahoo Finance that a Democratic victory would quickly lead to Kraninger’s impeachment. His replacement, Boltansky said, “will prioritize a review and reopening of the rule to restore the original repayment capacity construct that was central to Cordray’s rule.”
Kaplinsky said the industry itself could also challenge the CFPB in court. Lenders upset with the rule’s payments provision – the cap on the number of times a lender can attempt to withdraw funds – may attempt to argue that the rule is a violation of the Administrative Procedure Act governing the bureaucratic rule-making process.
“It’s like everything else, if someone gets what they want, they always want a little more,” Kaplinsky said.