Can Payday Loans Really Be Regulated?
Payday loans are a cross between the weather and art. They’re like the weather because everyone talks about them; they’re like art because they’re ultimately impossible to define yet everyone knows it when they see it.
This was the week regulators highlighted the importance of dealing not only with payday loans, but direct deposit account loans. First, the CFPB came out with its white paper analyzing the market for these products and pointing out that its analysis applied to both banks and credit unions. Then the OCC, spurred on no doubt by the CFPB and a Wall Street Journal article reporting that a guidance was imminent, released a proposed guidance on the proper management of direct advance products. Of course, the OCC has no jurisdiction over credit unions, but given the CFPB’s interest in the issue, it’s hard to see how increasing examiner emphasis on short-term loan products won’t impact at least state chartered credit unions in states that allow payday loans. (Given New York State’s criminal usury rate of 25% and the interest rate cap imposed on federal credit unions, credit unions in New York State couldn’t offer payday loans even if they wanted to).
First some background. The OCC defines a deposit advance product as a short-term credit product offered to a consumer maintaining a deposit account, reloadable prepaid card or other similar bank related product. Banks that offer the product allow customers to take out a loan in advance of the customer’s next scheduled direct deposit. As a result, they are similar, but not identical to traditional payday loans that aren’t tied to a specific account. Nevertheless, both the OCC and the CFPB in its white paper understandably see the products as posing the same risk to consumers.
Another commonality highlighted by both the CFPB’s white paper and the OCC’s proposed guidance is that both recognize the need for short-term loan products. As explained by the CFPB, “these types of credit products can be helpful for consumers if they are structured to facilitate successful repayment without the need to repeatedly borrow at a high cost.” The Bureau goes on to explain that what it is most concerned about is the long-term use of these lending products resulting in rolled over loans and higher fees.
So how do you regulate a potentially dangerous financial product that you nevertheless recognize a need for? One potential solution could be tighter underwriting standards. Both the CFPB and the OCC note that few financial institutions that offer these products do so with regard to a consumer’s ability to repay the loan. As explained in the OCC’s proposed guidance, eligibility and underwriting criteria for deposit advance loans should be “consistent with the eligibility and underwriting criteria for other bank loans.” In addition, whatever underwriting criteria is developed by a bank “the criteria should be designed to ensure that the extension of credit can be repaid according to its terms while allowing the borrower to continue to meet” typical expenses.
Federal scrutiny of payday loan practices and standards is long overdue. Given the ability of financial institutions to export payday loans into states that don’t authorize them for their own charters, only uniform national standards can regulate the payday loan market. In addition, applying ability to repay standards to payday loans is perfectly consistent with the emphasis that regulators are placing on this basic idea in other areas such as mortgages. Still, as well intended as these proposals may be, there will always be people in desperate need of money and other people willing to take advantage. In addition, applying ability to repay standards sounds good, but if these consumers could meet basic underwriting standards, they presumably wouldn’t need short-term loans in the first place.
The bottom line: there will always be short-term loans, many of which are predatory. The best thing credit unions can do is to expand their offerings of responsible, short-term lending products. They may not be immediately cost-effective, but their long-term benefit both to getting new members into our doors and underscoring the credit union difference could be of tremendous benefit to the industry.