By Marie Hogan and Jonathan Joseph
The President of the United States sent a wake-up call to the payday lending industry in his 2012 State of the Union speech that they are a target of federal enforcement action by the new Consumer Protection Financial Bureau or CFPB. President Obama exclaimed:
“If you’re a mortgage lender or payday lender or a credit card company, the days of signing people up for products they can’t afford with confusing forms and deceptive practices—those days are over.”
Almost a week before the speech, the Consumer Financial Protection Bureau, the newest federal agency whose name describes its mission, published its guidelines for examinations of short-term, small-dollar lenders (aka “payday lenders”). Payday lenders and other non-bank financial service providers that have never been subject to direct federal regulation will now be under the jurisdiction of the CFPB.
The CFPB’s guidelines and the President’s call out indicate the payday lending industry has clearly been targeted due to perceived abuses. The initial guidelines for the payday lending industry consist of 17 pages and are a supplement to the CFBB’s 802 page examination handbook. The management and boards of directors of payday lenders that desire to comply with the CFPB’s regulations should familiarize themselves with the guidelines and implement expanded compliance systems.
WHAT is the CFPB’s purpose?
The CFPB will implement and enforce Federal consumer financial law consistently for the purpose of ensuring that all consumers have access to markets for consumer financial products and services and that the market for consumer financial products and services are fair, transparent, and competitive. They will especially target lenders engaging in unfair, deceptive or abusive acts or practices.
WHY payday lending?
Payday loans are supposed to be short term: 14 days. As the name implies, they’re supposed to provide emergency cash to enable consumers to cover short term necessities until the next pay day, when they theoretically should be able to repay the loan. Critics say this is typically not the case. Customers often roll-over their debt when they can’t repay it. They wind up living off that borrowed money at an annual interest rate of 400 to 600 percent or more.
Here’s how it works. Let’s say an individual needs $100 and the interest rate for that two week period is 15 percent. The customer writes a postdated check made out to the lender for $115. If the customer can’t pay that amount when the two weeks is up, the lender keeps $15, the loan is extended and another $15 fee is added on.
The CFPB is still in the fact gathering mode regarding the payday industry, holding hearings earlier this year in Birmingham, Alabama. However, the industry is number two in its list of priorities. Richard Cordray, the CFPB’s executive director, said the agency will examine bank and non-bank institutions offering these short-term, small-dollar loans. At the Birmingham hearing, Cordray expressed this sentiment:
“We recognize that there is a need and a demand in the country for emergency credit. At the same time, it’s important that these products actually help consumers and not harm them. We know that some payday lenders are engaged in practices that present immediate risks to consumers and are illegal. Where we find these practices, we will take immediate steps to eliminate them.”
WHAT is the scope of CFPB’s responsibility?
CFPB has responsibility for specified federal consumer financial laws, such as Truth in Lending and the Fair Credit Reporting Act and certain Federal Trade Commission rules, such as the Credit Practices rule. The CFPB may also issue rules, and even without a rule, it may examine for unfair, deceptive or abusive acts or practices that cause significant financial injury to consumers, erode consumer confidence, and undermine the financial marketplace.
WHICH payday lenders can the CFPB examine?
Any payday lender, in any state, whether regulated or not, can be examined. The CFPB has the power to take enforcement actions against any payday lender. The first step for the CFPB is an examination of the company for compliance with federal consumer financial laws and unfair, deceptive or abusive acts or practices. An important point is that the examination guidelines merely provide a roadmap for what a company needs to do. The CFBP’s guidelines don’t provide detailed direction to a payday lender but the CFBP will provide notice through the examination process regarding the company’s demerits and legal violations. The CFPB has a scale of 1-5 (one being the best) that will be awarded in an examination. In general, all payday lenders should strive to earn 1 or 2 ratings in all sub-categories that are reviewed.
The CFPB may investigate and bring administrative enforcement proceedings or civil actions in Federal district court for violations of federal consumer financial laws. The CFPB additionally may obtain “any appropriate legal or equitable relief with respect to a violation of Federal consumer financial law” including: 1) rescission or reformation of contracts; 2) refund of money or return of real property; 3) restitution, disgorgement or compensation for unjust enrichment; 4) payment of damages or other monetary relief; 5) public notification regarding the violation; 6) limits on the activities or functions of the person against whom the action is brought; and 7) civil money penalties (which can go either to victims or to financial education).
The CFPB has no criminal enforcement authority; however, it may refer matters it believes may constitute criminal activity to the Department of Justice.
Payday Lender Examinations: What should management know?
The examination procedures are very much based on bank/financial institution formats. Here is our list of how this system works based on years of experience and working with the regulatory agencies:
First, policies and procedures must be in writing. That means the payday lender’s Board of Directors should establish detailed written procedures covering all significant compliance risks and processes.
Second, procedures must address compliance with federal consumer financial laws, as well as addressing other risks.
Third, the Board must be intimately involved in establishing policy, overseeing management and insisting that management comply with its policies.
Fourth, companies must train and monitor their employees.
Fifth, monitor audit procedures and processes and address all criticisms from internal and external auditors, state regulators and the CFPB.
Sixth, compliance must cover “soup to nuts”, meaning from product development to end of customer relationship and every significant step in between.
Seventh, appoint a compliance officer with real authority and responsibility. For smaller companies, this may be an employee who has other responsibilities, but take steps to assure that the compliance officer is qualified.
Eighth, the company must monitor any third party service providers for compliance with the above.
The CFBP examination objectives are:
1. To assess the quality of compliance risk management systems, including internal controls and policies;
2. To identify acts or practices that materially increases the risk of violations of federal consumer financial laws;
3. To gather facts that help determine whether the lender is engaged in acts or practices that violate the requirements of federal consumer financial laws;
4. To determine if a violation of a federal consumer financial law has occurred and whether enforcement actions are appropriate.
Which Federal Laws Are Applicable to Payday Lenders?
- TILA and Regulation Z—TILA is the Truth in Lending Act and Regulation Z require lenders to disclose loan terms and annual percentage rates. Regulation Z also covers advertising disclosures, proper crediting of payment, proper crediting of credit balances and periodic disclosures.
- EFTA and Regulation E—EFTA is the Electronic Funds Transfer Act which protects consumers engaging in electronic transfers, including that lenders may not require, as a condition of loan approval, the customer’s authorization for loan repayment through recurring electronic funds transfers.
- FDCPA—This is the Fair Debt Collection Practices Act which governs collection activities conducted by (a) third party collection agencies and (b) lenders collecting their own debt under an assumed name.
- FCRA— This is the Fair Credit Reporting Act which, with its regulations, governs furnishing information to credit agencies and the use of credit reports.
- GLBA – This is the Gramm-Leach-Bliley Act which, together with implementing regulations, requires that furnishers of information to consumer reporting agencies ensure the accuracy of data furnished to the consumer reporting system.
- ECOA—This is the Equal Credit Opportunity Act which, together with implementing Regulation B, sets requirements for accepting credit applications and providing notice of any adverse action. Discrimination against a borrower is prohibited, plus discrimination based on public assistance income or because the applicant has exercised any right under the Consumer Credit Protection Act is prohibited.
Some payday lenders do attempt to comply with applicable law. However, bad actors in the industry have contributed to the perception that widespread abuses exist. Companies in the “short term small dollar” lending business that desire to avoid potential CFPB enforcement sanctions should implement compliance systems and procedures modeled after those used in the banking industry designed specifically to comply with the laws listed above. This may entail adding risk and compliance officers to existing management teams, robust internal controls and better policies and procedures.
Jonathan Joseph at [email protected]; or
Marie Hogan at [email protected].