Revisiting small loans rules crucial to maintaining access to credit for vulnerable consumers

Revisiting small loans rules crucial to maintaining access to credit for vulnerable consumers
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Congress recently held a hearing on the small-dollar loan industry and how to protect consumers from predatory lenders. This is a timely discussion, and one that demands historical context. In considering reforms, lawmakers should take care not to restrict access to credit for the most vulnerable Americans.

Under the guise of looking out for consumers who are trying to obtain loans, the prior administration set in motion regulations that would put these very consumers in jeopardy by restricting their access to credit. Specifically, in the waning days of the Obama administration, the Consumer Financial Protection Bureau (CFPB) took steps to adopt regulations that require lenders to underwrite small-dollar and short-term loans, including payday, single-payment vehicle title, and even longer-term balloon payment loans.

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Underwriting is the process of assessing a borrower’s financial health to ensure that the risk of default is acceptable. Essentially, the CFPB rule would require lenders to certify that the recipient of a loan has the ability to repay it. The rule assumes that consumers can’t be trusted to decide for themselves when loans are too costly. Mandatory underwriting for small-dollar credit creates a significant administrative cost, drying up capital, and delaying access to credit for people in urgent situations who have no alternative sources of cash to pay their bills, fill their gas tank, or put food on the table.

The CFPB recent announcement that it will re-evaluate these new rules that would restrict access to small-dollar loans for millions of vulnerable Americans should be applauded. With 4 in 10 Americans adults unable to cover an unexpected $400 expense, the government should be taking steps to expand access to credit for low-income households, not reduce it.

In announcing its decision to revisit the underwriting provision, which was slated for implementation later this year, the CFPB noted that the rule could “reduce access to credit and competition in states that have determined that it is in their residents’ interests to be able to use such products, subject to state-law limitations.” Indeed, imposing onerous regulations would threaten disruptive, innovative small-dollar lending services just as they’re beginning to compete against traditional payday loans by offering more convenient, secure, and affordable services.

Minimal regulation and vigorous competition will do more to benefit consumers than government regulations that favor large, incumbent lenders over promising start-ups.

Though small-dollar lenders have been portrayed as ruthlessly preying on the disadvantaged, characterizing an entire industry based on the behavior of some bad actors is inaccurate. Because these loans can have a high risk of default, they can carry high interest rates. But most consumers know what they’re getting into and are fully capable of repaying their loans. Continuing to educate consumers is important, but the truth is that millions of Americans would be worse off without access to small-dollar loans.

Banks avoid consumers with low incomes and poor credit scores. Restricting small-dollar lending removes one of the few sources of credit available to these consumers and risks driving them into underground markets or illegal activity.

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When big banks turned their backs on consumers during the last recession, alternative sources of credit became vital. After the economy collapsed in 2008, banks — particularly large and regional institutions — sharply reduced lending as rejection rates for small business loans soared to 60 percent and total loans fell 20 percent. In response, many small community banks and credit unions stepped in, showing the importance of smaller, local sources of longer term funding to businesses.

Similarly, payday and other small-dollar loans fill a need for less wealthy consumers who need a quicker turnaround than other financial institutions can offer or who have been locked out of traditional banking services entirely.

Mandatory underwriting and curbing access to credit for low-income consumers evokes echoes of redlining, the practice of denying loans to residents of certain neighborhoods based on demographic, racial, or economic characteristics. Banks have long been accused of using geography to screen customers and avoid extending credit to low-income communities, people of color, and those living in high-crime areas. As recently as 2015, the CFPB took action against a bank over allegations of redlining.

To what extent do onerous restrictions on small-dollar loans facilitate legalized redlining and discrimination against those Americans already struggling the most?

Access to credit is vital for families and communities to invest and grow. For the millions of Americans who rely on small-dollar loans as a last resort, the CFPB’s decision to reconsider placing additional restrictions on these loans should be welcome news.

Liam Sigaud works on economic policy and research for the American Consumer Institute, a nonprofit educational and research organization. For more information about the Institute, visit www.TheAmericanConsumer.Org.