The Consumer Finance Protection Bureau’s (CFPB) pending payday loan ruling has been on a turbulent ride since its initial proposal towards the end of the Obama administration. Originally proposed under then-director Richard Cordray, the ruling directed traditional payday lenders to limit the dispersal of payday loans and other high-cost, small dollar loans by requiring an underwriting process that can adequately assess a borrowers’ ability to repay.
The regulations would fundamentally change the nature of small dollar loans in this country, possibly even ending the services of many traditional payday lenders. The CFPB regulations are the result of repeated efforts to regulate predatory lending practices and minimize debt traps that have victimized Americans for nearly three decades. That decision was put on hold at the very least with current director Kathleen Kraninger and the CFPB on July 7, 2020, when the agency officially reversed this “ability to repay” underwriting provision.
Enter president-elect Joe Biden’s incoming administration who, it has been reported, is strongly reconsidering CFPB policies as well as replacing Kraninger as agency director.
The issue of payday lending and consumer financial protections overall has far reaching consequences beyond the scope of impacting payday lenders; it affects credit unions, banks, and millions of underbanked Americans alike.
The Underbanked Consumer
According to Pew Trusts, approximately fifty million people in the United States are either unbanked, meaning they have no checking or savings account, or underbanked, meaning they have some interactions with traditional financial institutions, but rely on the services of alternative financial service providers. Small-dollar loans are one of the most prominent financial services the underbanked use to access cash. The underbanked rely on less-regulated payday lenders because they lack financial alternatives that most people use. There are twelve million Americans who regularly use payday loan services. These consumers spend more than $7 billion on loan fees outside the initial capital borrowed. Recent Pew data showed that the average payday loan customer pays $520 in finance charges for every $375 in principal borrowed. Though the $375 loan is advertised for two weeks, on average the borrower remains in debt to the payday lender for closer to five months. These high fees are the cost many Americans must pay to gain necessary liquidity.
Impact on Consumers
Many payday lenders’ practices take advantage of their customers through interest rates that average 426 percent APR in the United States. Consumers want the current system to change, but still want access to small dollar loans. When questioned about the need for payday loan reform and the creation of alternative access to small dollar loans, more than 70 percent of Americans wanted stronger regulations on the payday loan market and lower-cost, small loans options available through traditional financial institutions. CFPB research indicated that should the new regulations be implemented, there would be a 71.66 percent reduction in the number of loans offered by payday lenders. While the exact impact is hard to measure, payday and title loan companies will have to innovate to survive under the new regulations.
Beyond reforming the payday lending industry, it is hoped that the new CFPB regulations, regardless of the incoming Biden administration’s policy changes, will eventually guide consumers towards better, more financially healthy alternatives to payday loans. A major goal of the CFPB regulations is to encourage traditional financial institutions like credit unions to offer alternative small dollar loans with more manageable payments and increased safeguards for consumers. Consumers are faced with a dilemma as CFPB reforms draw closer. If no viable alternative service for small dollar loans is created before new regulations are implemented, as damaging as existing payday lenders can be, the initial impact of proposed CFPB regulations limiting payday loans would leave unbanked and underbanked consumers without an important financial service. With the implementation of CFPB regulations looming, there is a growing responsibility for financial institutions like credit unions to provide a viable alternative for small dollar loans.
Opportunity Knocks for Credit Unions
If the older rules reduce the volume of loans issued from payday lenders by 70 percent, there will be a significant gap in the market which needs to be addressed. Traditional financial institutions need to start preparing immediately in order to ensure that millions of Americans have access to loans, but some financial institutions are better positioned to take advantage of the open market. Specifically, credit unions have an ideal opportunity to fill the gap in the market caused by payday loan regulations. Many of the underbanked in this country use credit unions to provide basic financial services, but do not use them for small-dollar loans. The number of small-dollar loans issued by credit unions is less than one percent of the volume of payday loans issued in a year. By leveraging relationships and account histories, credit unions will be able to offer better small-dollar products at lower rates to their members.
Both credit unions and banks have traditionally shied away from small-dollar loans because of three prevalent myths: it isn’t profitable to work with the underbanked, compliance will be more challenging and it will hurt the reputation of the financial institution. These assumptions are simply not true. Small dollar loans should be viewed as a potential source of revenue like any other financial product. Automated systems are able to make offering small-dollar loans to the underbanked profitable while ensuring that compliance standards are met. Now, more than ever, the idea that offering small dollar loans would hurt a credit union’s reputation is a myth. Lawmakers and regulators realize they need financial institutions to fill the gap in the market created by potential CFPB regulations on payday lenders and have repeatedly called for them to do so. Rather than hurting their reputation, credit unions who step up to tackle the problem will be viewed as leaders and innovators.
Credit unions need guidance, not regulation
In order for the transition from traditional payday lenders to credit unions to be successful, the CFPB must ensure no additional regulations on credit unions are passed which may interfere with the ability to provide small-dollar loans. Fair Lending standards, Unfair, Deceptive, or Abusive Acts or Practices (UDAAP) regulations and the limits to interest rates on payday loans already ensure that CUs are well-regulated. Any extra reporting and verification requirements will only hinder their ability to offer alternatives at an affordable rate to cover operational overhead. Overly rigorous compliance standards will be a barrier for credit unions to offer better alternatives to payday loans to underbanked consumers.
Financial institutions should not be discouraged from offering small-dollar loans because of additional red tape that delays the loan approval process. For instance, the credit union or bank should not be required to report to or check any additional database outside its own records. Requiring any additional external verification or manual efforts to deliver these types of loans will increase costs and lower the probability of credit union adoption. The proposed limitations on small dollar loans may create unintended consequences and drive consumers to meet their financial needs in new, as yet undefined, ways containing unnecessary risks.
New Opportunity Means Greater Responsibility
Whether or not the new regulations on payday lenders are implemented, banks and credit unions have a responsibility to move towards offering small dollar loans to consumers. With few financial institutions offering small dollar loan services, there is a growing need for a better alternative to traditional payday loans. Credit unions are particularly at a competitive advantage to enter the small dollar loan market. These member-owned cooperatives can leverage their relationships and history with credit union members to create a better alternative to payday lending now, regardless of CFPB regulations. The mission of a credit union is to offer services that meet members’ financial needs. The opportunity is there, the need is established, and it’s up to financial institutions to take responsibility.
QCash Financial can be that answer for your local credit union. Our automated, SaaS-based, white label, digital small dollar lending platform can help retain members and build brand loyalty by offering responsible and immediate access to the liquidity your members need, when they need it, with no credit check. Our small dollar loan product is designed to help strengthen the financial future of families across the nation and the communities in which they live. Allow us to be another asset in your credit union suite of products to help transform your members’ lives for the better, especially in this tumultuous time of COVID.Feel free to contact us any time about giving every credit union member the capacity to create and achieve financial health with our QCash digital small dollar lending product.