The Consumer Financial Protection Bureau (the “CFPB” or “Bureau”) recently issued the long-awaited final rule concerning Payday, Vehicle Title, and Certain High-Cost Installment Loans (the “Final Rule”). While it is clear that the Final Rule will ban certain practices that are currently central to the business model of payday lenders, vehicle title lenders, and other high-cost installment lenders, research evidences that the market demand allowing these products to flourish will persist.
Today’s consumer credit market evidences the need for underwriting models that are sufficiently flexible and adaptable to account for data beyond traditional credit files so that lenders can effectively evaluate credit risk. Arguably, traditional financial institutions such as banks and credit unions have largely exited the small dollar loan market rather than solve for this problem, while payday lenders and other non-traditional lenders have, perhaps, overpriced their products to account for risk that they have failed to quantify. To that end, certain industry observers will argue this dynamic has created a shortage of small-dollar consumer credit that is both accessible and sustainable for consumers. While federal banking agencies have focused on the exit of banks and credit unions, the CFPB under a Dodd-Frank mandate has focused on certain features of payday loans, vehicle title loans, and high-cost installment products.
While some entities may challenge the Final Rule and seek a rollback of its requirements through the Congressional Review Act (the “CRA”), if the Final Rule ultimately goes into effect it will present an opportunity for the realignment of the consumer finance market. Those entities that are prepared to work within the framework created by the Final Rule may see the CRA as a blueprint for the future of consumer lending.
II. SCOPE OF THE RULE
Originally proposed as the “Small Dollar Rule,” the Final Rule departs from the emphasis on loan size to focus principally on what the CFPB labels as the “debt trap” associated with short-term consumer loans with a term of 45 days or less repayable in a single installment (“Covered Short-Term Loans”), and those longer-term consumer loans with balloon payments (“Covered Longer-Term Balloon Payment Loans”). In addition to requiring that lenders determine a consumer’s ability to repay for these loan products at the time of origination, the Final Rule addresses certain collections practices and imposes reporting and recordkeeping requirements. The collections practices and recordkeeping practices extend to a wider class of consumer loans, including certain other installment loans not subject to the underwriting or reporting requirements. Departing from the proposed rule, the Bureau did not ultimately extend the underwriting requirements to the origination of installment loans more generally.
As stated above, the remainder of the Final Rule, which addresses collections and recordkeeping requirements, extends beyond those loan products subject to the underwriting and reporting requirements to include “Covered Longer-Term Loans,” which are defined as loans with greater than 36% APR and for which the lender has obtained a “leveraged repayment mechanism” (i.e., the right to withdraw payment directly from a borrower’s account).
Excluded from the Final Rule are:
- loans extended solely to finance the purchase of a car or other consumer good in which the loan is secured by the good;
- home mortgages and other loans secured by real property or a dwelling if recorded or perfected;
- credit cards;
- student loans;
- non-recourse pawn loans;
- overdraft services and lines of credit;
- wage advance programs; and
- no-cost advances of funds.
In addition “alternative loans” and “accommodation loans” are exempted from the Rule subject to certain conditions.
We note that there is no affirmative exclusion for banks, credit unions, or any other type of financial institution, as the scope of the Final Rule is dictated by loan terms rather than the entity type making such loans. The application of the requirements to banks is particularly important given the decision by the Office of the Comptroller of the Currency (“OCC”) to rescind its 2013 deposit advance guidance, which had aimed to steer smaller banks away from offering deposit advance products, which historically operated much like payday loans. It remains to be seen whether the Federal Deposit Insurance Corporation (“FDIC”) will follow suit in reversing its guidance. Nevertheless, the application of the Final Rule to banks and credit unions means that depository and non-depository lenders alike must evaluate their loan products within the context of the Final Rule.
III. REQUIREMENTS OF THE FINAL RULE
The Final Rule comprises three main parts:
- underwriting standards, including ability to repay requirements and related loan limits (applicable to Covered Short-Term Loans and Covered Longer-Term Balloon Payment Loans);
- collections requirements, which address the initiation of payment withdrawals directly from consumers’ accounts (applicable to Covered Short-Term Loans, Covered Longer-Term Balloon Payment Loans, and Covered Longer-Term Loans); and
- reporting requirements (applicable to Covered Short-Term Loans and Covered Longer-Term Balloon Payment Loans) and recordkeeping requirements (applicable to Covered Short-Term Loans, Covered Longer-Term Balloon Payment Loans, and Covered Longer-Term Loans).
Relying upon the Dodd-Frank mandate to the CFPB to address unfair and deceptive practices, the Final Rule deems a failure to determine consumers’ ability to repay Covered Loans at the time of origination, prescribing certain underwriting requirements, and related loan limits as an unfair and deceptive practice. To determine the borrower’s ability to repay Covered Short-Term Loans and Covered Longer-Term Balloon Payment Loans, the lender must apply a "full payment test," which requires a reasonable determination of the consumer’s ability to repay the loan and cover major financial obligations and living expenses over the term of the loan and the 30 days after the loan’s maturity date. As an alternative, in lieu of a “full payment test,” the lender may provide borrowers with a “principal-payoff option,” which allows for the gradual reduction in the debt through a series of three sequential loans: the first such loan with a principal balance of up to $500, the second loan at least one-third smaller than the first loan, and the third loan at least two-thirds smaller than the first loan.
We note that because the Final Rule simply requires that the lender make a “reasonable determination” regarding the consumer’s ability to repay (if a principal-payoff option is not provided), we see an opportunity for lenders to innovate and develop underwriting models that are tailored to address the default risks presented by their customer base and loan portfolio.
The Final Rule also deems unfair and deceptive lenders’ practice of attempting to withdraw payment from consumers’ accounts after two consecutive failed attempts due to insufficient funds without first providing the consumer notice and obtaining reauthorization. To make an additional payment attempt for Covered Short-Term Loans, Covered Longer-Term Loans, and Covered Longer-Term Balloon Payment Loans (a “Covered Loan”), after two failed attempts, the Final Rule requires lenders to obtain either consumer authorization for additional attempts or consumer authorization for a one-time transfer. The authorization provisions are triggered after the “first failed payment transfer” and the “second consecutive failed payment transfer.” To receive authorization for additional payment attempts, the lender must provide the consumer with the payment transfer terms and a consumer rights notice either by mail, in person, over the phone, or electronically. Alternatively, the lender may initiate an additional payment transfer if the consumer contacts the lender to discuss repayment options or requests the lender make a one-time transfer via an electronic fund transfer or a signature check.
In addition, the Final Rule requires lenders to provide consumers with a written or electronic “payment notice,” and when appropriate, a “consumer rights notice.” A “payment notice” must be issued before making the first payment transfer on a Covered Loan or a payment attempt that differs in amount, timing, payment channel, or is the result of a returned transfer. A “consumer rights notice,” on the other hand, is issued only after a lender has made two consecutive failed payment attempts. The Final Rule requires both notices to use language “substantially similar” to model clauses found in the appendices of the Final Rule.
C. REPORTING AND RECORDKEEPING
The Final Rule establishes a new type of reporting regime that requires lenders to furnish information concerning each Covered Short-Term Loan and Covered Longer-Term Balloon Payment Loan to Provisionally Registered and Registered Information Systems (each a “RIS”) as of the date the loan is consummated, during the period that the loan is outstanding, and at the time the loan ceases to be an outstanding loan. Conversely, the information provided by various lenders to an RIS will also provide lenders with access to a record of a consumer’s borrowing history specific to Covered Short-Term Loans and Covered Longer-Term Balloon Payment Loans when lenders make their underwriting determinations. Additionally, lenders must also develop and implement an internal record retention program for each Covered Short-Term Loan, Covered Longer-Term Balloon Payment Loan, and Covered Longer-Term Loan, which includes retention for 36 months after the date on which subject loans are satisfied.
Because the reporting apparatus created by the Final Rule hinges on these RISs, and there is still much that we do not know about how they will operate, this requirement has the potential to give rise to a new swath of financial service providers, particularly those with systems that are compliant with the wider array of applicable data privacy and security regimes. It also remains to be seen whether such RISs will help thin-file consumers develop a credit history that will be useful in establishing traditional forms of credit.
The Final Rule establishes steps and eligibility criteria to become an RIS; each of these entities will hold the records involving consumers and their Covered Short-Term Loans and Covered Longer-Term Balloon-Payment Loans. Eligibility criteria to become an RIS include the following:
- the capability to receive furnished information from lenders and to generate consumer reports;
- a Federal consumer financial law compliance program (as demonstrated by an independent assessment);
- a comprehensive information security program (as demonstrated by an independent assessment); and
- the ability to facilitate compliance with the Rule.
IV. LOOKING FORWARD AND TIMING
We note that the Final Rule remains subject to the CRA, which allows Congress to prevent the Final Rule from going into effect by passage of a joint resolution in both the House and Senate. While there may be enough votes for the resolution to pass through the House, the resolution, in the view of our Legislative Affairs Group, is unlikely to pass through the Senate. Absent a repeal of the Rule using the CRA, the Rule will go into effect 21 months after its publication in the Federal Register.
We understand that opponents of the Final Rule consider the requirements unduly burdensome and, in some cases, tantamount to a ban. However, given the apparent likelihood that the Rule will ultimately become effective, an interesting question is what we should expect in the way of a market response. Who is positioned to service the consumers that have traditionally relied on these products? Payday lenders contend that loan sharks and other illicit enterprises will flourish if formal non-traditional lenders are unable to market their product. Others believe that installment lenders are advantageously positioned. We, however, believe the solution may provide an opportunity for fintech.
We understand that extending loans under $7,500 is typically not profitable for a bank and payday lenders. Payday lenders explain that such loans cannot be made profitably without a triple digit APR given the risk of non-payment. To that end, we understand that payday lenders (and some banks) may push back on the Final Rule. Alternatively, though, the Final Rule could be viewed as a blueprint for a fintech company to provide these loans in accordance with the Final Rule by bringing technology to bear on this issue in a way not done previously.
We can argue about the merits of the requirements imposed by the Final Rule, but at the end of the day, industry and consumer advocates alike can agree that the Final Rule itself is highly disruptive. It is in this disruption, however, that we see fintech firms poised to offer real, sustainable solutions to a market that has long been much too fragmented. From this perspective, the Final Rule may be viewed a blueprint for the future of short-term consumer lending.
 UNC Center for Community Capital “North Carolina Consumers After Payday Lending: Attitudes and Experiences with Credit Options” (November 2007) available at http://communitycapital.unc.edu/files/2007/11/NC_After_Payday.pdf. (Finding that following the interest rate cap instituted by the State of North Carolina that effectively banned payday loans, former payday borrowers reported using an array of options to manage financial shortfalls and, as a result, the vast majority of households surveyed reported being unaffected by the end of payday lending).
 See Federal Deposit Insurance Corporation, Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products (2013), available at https://www.fdic.gov/news/news/press/2013/pr13105a.pdf. See also Office of the Comptroller of the Currency, Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products (2013), available at https://www.occ.gov/static/news-issuances/bulletins/rescinded/bulletin-2013-40.pdf. We note that the OCC guidance was rescinded on October 5, 2017.
 Dodd-Frank Wall Street Reform and Consumer Protection Act, 12 U.S.C. § 5514(a)(1)(E), (d) (2010).
 See 12 C.F.R. § 1041.3 (b)(1) (A “covered short-term loan” means “for closed-end credit that does not provide for multiple advances to consumers, the consumer is required to repay substantially the entire amount of the loan within 45 days of consummation, or for all other loans, the consumer is required to repay substantially the entire amount of any advance within 45 days of the advance”).
 See 12 C.F.R. § 1041.3(b)(2) (A “covered longer-term balloon-payment loan” means, “[f]or closed-end credit that does not provide for multiple advances to consumers, the consumer is required to repay substantially the entire balance of the loan in a single payment more than 45 days after consummation or to repay such loan through at least one payment that is more than twice as large as any other payment(s). For all other loans, either: (A) The consumer is required to repay substantially the entire amount of the advance in a single payment more than 45 days after the advance is made or is required to make at least one payment on the advance that is more than twice as large as any other payment(s); or (B) A loan with multiple advances is structured such that paying the required minimum payments may not fully amortize the outstanding balance by a specified date or time, and the amount of the final payment to repay the outstanding balance at such time could be more than twice the amount of other minimum payments under the plan”).
 See 12 C.F.R. § 1041.3(b)(3) (A lender or service provider obtains a “leveraged payment mechanism” if the lender has the right to initiate a transfer of money, through any means, from a consumer’s account to satisfy an obligation on a loan); Id. § 1041.3(c) ( A lender or service provider does not obtain a leveraged payment mechanism by initiating a single immediate payment transfer at the consumer’s request).
 See 12 C.F.R. §1041.3(d).
 The Final Rule provides an extensive list of requirements that must be met in order for a loan to qualify as an “alternative loan” or an “accommodation loan” that is exempt from the Rule. Generally, the issuance of alternative loans is subject to an income determination procedure, and the amount of accommodation loans issued must be under a cap to receive exemption. For a list of the requirements, see id. § 1041.3(e)-(f).
 U.S. Dep’t. of Treasury, Office of the Comptroller of the Currency, NR 2017-118, Acting Comptroller of the Currency Rescinds Deposit Advance Product Guidance (2017).
 Dodd-Frank Wall Street Reform and Consumer Protection Act, 12 U.S.C. § 5531(a)-(b) (2010).
 12 C.F.R. § 1041.7. The Final Rule applies to lenders attempting payment via electronic fund transfer, signature check, remotely created check or remotely created payment as well as lenders acting as the account-holding institution. See id. § 1041.8(a)(1)(i). However, if the lender is an account-holding institution and does not charge the consumer a fee, other than a late fee under the loan agreement, as a result of insufficient funds to cover the payment and does not close the account in response to a negative balance after a transfer of funds to cover the payment, the payment attempts will not qualify as a payment transfer within the scope of the Final Rule. See id. § 1041.8(a)(1)(ii).
 See 12 C.F.R. § 1041.2(a)(7), (8), (10).
 See 12 C.F.R. § 1041.8(c)(1).
 See 12 C.F.R. § 1041.8(b)(2)(i) (defining the “first failed payment transfer” as any failed payment transfer in which the lender has initiated no other payment transfer from the account in connection with the covered loan or any covered loan the consumer has with the lender; the immediately preceding payment transfer was successful, regardless of whether the lender previously initiated a first failed payment transfer or the payment transfer was the first to fail after the lender obtained consumer authorization for additional payment transfers).
 See 12 C.F.R. § 1041.8(b)(2)(ii) (stating the “second consecutive failed payment transfer” occurs when the immediately preceding payment transfer from the consumers account was a “first failed payment transfer” whether initiated at the same time or the same day as the second failed payment attempt).
 The lender must provide the specific date, amount, and payment channel of each additional payment transfer authorized, except when re-initiating a returned payment or collecting a late or returned item fee. See 12 C.F.R. § 1041.8(c)(2).
 See 12 C.F.R. § 1041.9(c)(1).
 See 12 C.F.R. §§ 1041.8(c)(3)(ii), 1041.9(b)(2)(i). Note, consumer rights notices may only be communicated in writing or electronically. See id. § 1041.9(c).
 A “single immediate payment transfer” may be carried out after the earliest of the following events: the consumer affirmatively contacts the lender to discuss repayment options or the lender provides the consumer with a consumer rights notice. See 12 C.F.R. § 1041.8(d). However, the signature check or authorization may not be provided to the lender until one of the events occurs. Id. § 1041.8(d)(2). The payment transfer must be made within one business day after the lender receives either authorization or the signature check. Id. § 1041.8(a)(2).
 See 12 C.F.R. § 1041.9(b),(c).
 This excludes the initial payment transfer after a consumer grants the lender authorization or requests a one-time transfer following two consecutive failed payment attempts. See 12 C.F.R. § 1041.9(b)(1)(iii). Note, under the payment notice requirements, a lender may be required to send a payment notice after a first failed payment transfer. See id. § 1041.9(b)(3)(ii)(4).
 For a complete list of payment notice requirements including content, timing, and delivery methods, see 12 C.F.R. § 1041.9(b)(2)-(4).
 For a complete list of consumer rights notice requirements including content, timing, and delivery methods, see 12 C.F.R.
 See 12 C.F.R. § Part 1041 app. a.
 See 12 C.F.R. § 1041.10(a). For a full list of the information that lenders must report, see id. § 1041.10(c).
 Id. The Bureau will publish on its website and in the Federal Register notice of the provisional registration of an information system, registration of an information system, and the suspension or revocation of the provisional registration or registration of an information system. See id. § 1041.10(b)(2). Crucially, it is currently unclear which entities will ultimately end up becoming Provisionally Registered and Registered Information Systems. The Bureau is essentially creating a new industry, and it is unclear how many companies are currently equipped with the existing infrastructure to pass the eligibility criteria imposed by the Bureau in the Final Rule. The costs to create the necessary infrastructure in order to become a Provisionally Registered or Registered Information System would be enormous. Furthermore, any entity electing to become a Provisionally Registered or Registered Information System would also be voluntarily subjecting itself to the supervision of the Bureau, which isn’t exactly an appealing proposition.
 12 C.F.R. § 1041.10(a).
 See 12 C.F.R. § 1041.5(c)-(d).
 See 12 C.F.R. § 1041.12 (listing the types of information that must retain, as well as information regarding the electronic tabular format in which such information must be retained); 12 C.F.R. § 1041.12(b).
 For example, although beyond the scope of this article, lenders who possess consumer information will have to comply with the Fair Credit Reporting Act (“FCRA”) and the Fair and Accurate Transactions Act of 2003 (“FACTA”) Disposal Rule concerning information derived from consumer reports.
 See 12 C.F.R. § 1041.11(b).
 Please note that 12 C.F.R. § 1041.11, regarding RIS will become effective 60 days after publication in the Federal Register. This portion of the Final Rule must become effective earlier in order to implement the new consumer reporting elements of the Final Rule.