With new leadership at the Consumer Financial Protection Bureau (CFPB), there is rising concern that there will be renewed attempts to cap effective interest rates on small dollar loans. This would be a mistake for several reasons.
First, the CFPB has no power to impose a usury cap. The Dodd-Frank Act that created the Bureau states:
No provision of this title shall be construed as conferring authority on the Bureau to establish a usury limit applicable to an extension of credit offered or made by a covered person to a consumer, unless explicitly authorized by law. (12 U.S.C. §5517(o))
Any interest rate cap on small dollar loans is effectively a usury cap. The Cordray-era CFPB proposed a rule that instituted a de facto prohibition on loans to persons who did not meet “ability-to-repay” requirements when those loans present a total cost of credit greater than a 36 percent annual percentage rate (APR.) It argued that this was not a usury cap, as there were circumstances in which loans could be granted.
However, the requirements for extending a loan beyond that limit were so onerous that many potential borrowers would simply not qualify, and most lenders would not attempt to see if they can. Without the 36 percent requirement, some of these loans would probably have been made. That made the 36 percent figure an effective limit. It is likely that the new CFPB will try to make similar arguments in any new rulemaking.
Furthermore, the idea of a rate cap using annual percentage rates is misplaced when it comes to small-dollar loans. As John Berlau argued in his CEI study, “The 400 Percent Loan, the $36,000 Hotel Room, and the Unicorn,” applying annualized analyses like APR to loans of much shorter duration is an apples-to-oranges comparison. The Obama-era bureau argued that many small-dollar loan consumers were “trapped” in much longer cycles of debt, but as Hilary Miller argued in another CEI study, it failed to prove its case. As he said, “There is no evidence that payday lending traps consumers in a cycle of debt, that it is harmful, or that the particular numerical limits on reborrowing the CFPB has proposed will improve consumer welfare.”
Finally, the commonly-touted figure of a 36 percent APR cap has little rational basis and does not perform as advertised. The figure is simply the cap used in the Military Lending Act, where it was supposed to stop enlisted military personnel from getting into too much debt. However, as the bureau’s recent Task Force noted, “use of alternative financial products is estimated six to eight times higher among military families than among the general public,” which suggests that rate caps do nothing to lower the demand for alternative finance in those families.
As the Task Force concluded:
[H]undreds of years of study and experience have shown that usury laws interfere with credit availability and inclusion of marginalized borrowers. Usury ceilings promote convoluted circumvention practices such as term repricing that make product pricing and features less transparent and dampen competition. Usury ceilings often deprive consumers of preferred financial products and force them to turn to alternative providers and products that are more expensive and less desirable.
For these reasons, the new CFPB leadership should avoid setting either a de jure or de facto interest rate cap on small dollar loans.