Should the Federal Government Regulate the Fringe Credit Market?

The Dodd-Frank Wall Street Reform and Consumer Protection Act created the Consumer Financial Protection Bureau (CFPB) to monitor and supervise fringe creditors, study fringe markets, and promulgate rules relating to fringe banking transactions. Under these powers, the CFPB can regulate the fringe banking industry which includes payday lending. Here are some of the arguments for why the federal government should regulate fringe banking.


First, the industry relies on deceptive practices. These deceptive practices include extremely long and complicated consumer contracts that hide unfavorable terms. For example, lenders list the interest rate on a disclosure page instead of listing it with the other fees associated with the loan. Another way payday lending relies on deception is that many borrowers are overly optimistic about the likelihood that they will be able to pay off the loan. Borrowers often underestimate the cost of the loan because most borrowers end up rolling the loan over many times and incur additional fees which make the initial loan amount much more expensive than the borrower first perceived. The CFPB has power to promulgate rules to restrict these deceptive practices.


Second, the high costs associated with payday lending give rise to the argument that payday loans are a product with abusive pricing. Payday loans can be seen as usurious (the practice of making unethical or immoral monetary loans), imposing a high cost for a small amount of loan, and involve super high interest rates. The CFPB can regulate against abusive practices.


Third, some argue that fringe banking causes financial distress for borrowers. Although this view is contested, supporters believe that fringe banking negatively affects the national economy, traps borrowers in a debt cycle, and leads bankruptcy. Others argue that because the amount borrowed is so small, fringe credit transactions involve very limited debt loads as compared to other credit products like credit cards and mortgages. Therefore, fringe transactions make it unlikely that borrowers will become over indebted and experience financial distress from fringe lending. The CFPB can investigate practices and gather consumer information relating to the amount of financial distress actually experienced by fringe credit borrowers.


Finally, current federal regulations are not structured to adapt to frequently changing credit markets and are not effective at countering innovative creditor malfeasance. Payday lenders and other fringe creditors are good at avoiding restrictive regulations. The CFPB may be in a better position to learn about and act on these practices than a legislative body.


The CFPB is empowered to enforce actions against covered entities that engage in unfair, deceptive, and abusive acts or practices. The CFPB published “Examination Procedures Short-Term, Small-Dollar Lending” which states the standards for assessing unfair, deceptive, and abusive acts or practices as:

“I.    A representation, omission, act, or practice is deceptive when:

1.   The representation, omission, act, or practice misleads or is likely to mislead the consumer;

2.   The consumer’s interpretation of the representation, omission, act, or practice is reasonable under the circumstances; and

3.   The misleading representation, omission, act, or practice is material.

II.  An act or practice is unfair when:

1.   It causes or is likely to cause substantial injury to consumers;

2.   The injury is not reasonably avoidable by consumers; and

3.   The injury is not outweighed by countervailing benefits to consumers or to competition.

III. An abusive act or practice:

1.   Materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service; or

2.   Takes unreasonable advantage of:

i.    A lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service;

ii.   The inability of the consumer to protect its interest in selecting or using a consumer financial product or service; or

iii.  The reasonable reliance by the consumer on a covered person to act in the interest of the consumer.”

See CFPB Examination Procedures Short-Term, Small Dollar Lending

The CFPB plans to implement these standards when reviewing the practices of payday lenders. The CFPB plans to ensure payday lenders are complying with federal consumer protection laws by examining:

(a)  Lender marketing practices, policies, and procedures to determine if they are consisted with federal regulations;

(b)  Lender disclosure practices and other legal requirements when taking applications, evaluating applicants, and originating payday loans;

(c)  Lender compliance with federal regulations regarding payment processing and sustained use for the payday loan;

(d) How the lender collects a payday loan in default, assigns collection activity to a third party, or sells defaulted debts to third parties; and

(e)  The relationship between lenders and third parties which include the buying and selling of consumer information and the lender’s disclosure of its privacy policies to borrowers.

 For more information on how the CFPB plans to investigate payday lenders please click here.

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