Small-dollar, short-term lending continues to expand globally as access to traditional consumer credit tightens. Developed countries are noticing rapid expansions in their small-dollar lending industries, and many are looking for solutions on how to regulate this sector of consumer finance. Consumer advocates are demanding government regulation and are driving associated regulatory bodies to identify best practices for regulating this sector. Many of these regulatory bodies are looking to the United States as one of the oldest and most diversely regulated small-dollar lending marketplaces. The U.S. has 37 states with legal, regulated small-dollar lending. These jurisdictions each have unique regulations and regulatory frameworks that provide valuable insight into the best practices for the regulation of small-dollar, short-term lending.
The single most pressing issue for all jurisdictions is how small-dollar, high-cost consumer lending can be offered in a manner that prevents a cycle of financial distress on consumers. Balancing consumer protections with access to small-dollar, short-term credit in the marketplace has not proven easy. Finding this coveted middle ground is difficult and has left many jurisdictions searching for answers.
The United Kingdom
The small-dollar credit industry in the UK has more than doubled between 2010 and 2012, from £900 million to over £2 billion in annual short-term credit. This exponential growth spurred massive criticism, and on April 1, 2014, the Financial Conduct Authority (FCA) formally took control of regulating the consumer credit market. This includes the £2 billion, 500+ storefront and online payday lending industry. The FCA Chief Executive, Martin Wheatly, is on record saying,
“We have a big task ahead; it’s our job to make sure firms put their customers at the heart of their business and don’t just see them as an easy target or a profit line.
We won’t shy away from taking tough, decisive action to make sure that the people who rely on these products are treated fairly. There will be some firms that don’t get the message, or won’t play ball, those firms should know that we won’t let them carry on.”
These strong statements have experts concerned that many small-dollar credit lenders may choose to shut their doors rather than try and adopt tough regulations. New restrictions came into effect on July 1, 2014, and one trade organization is already claiming that lenders are leaving the market. Backing these concerns, the Competition and Markets Authority released a 12-month investigation into the payday lending industry in June, reporting that consumers may be overpaying for payday loans due to a lack of competition.
The UK and its regulatory bodies are clearly struggling with the growing pains of their small-dollar credit industries, and there is sure to be more pain before a resolution is found. Mrs. Jenny Chapman of the House of Commons said in a recent House of Commons debate,
“The United Kingdom is lagging behind on the regulation of consumer credit. The UK’s poorest borrowers pay the highest price for credit in Europe. Fifteen American states have now dealt with payday loans, and the cost of credit is also capped for all U.S. servicemen and women.”
The Australian Amendment
Australia has provided some of the toughest payday regulations and penalties in the world, but many question if it is enough. With a $1 billion payday lending market, the Australian Government has been struggling to regulate the industry for over a decade. Its most recent amendment, the Consumer Credit and Corporations Legislation Amendment Bill 2011, helped to plug some of the loopholes that lenders had been slipping through in overcharging consumers.
This new amendment establishes a cap of fees at 20% of the loan amount, and a law that does not allow a borrower to ever incur more than 200% of the original indebtedness. There are also stiff penalties for violating these new amendments, which include significant fines and jail time for abusers. The Australian Securities and Investments Commission (ASIC) has been tasked with regulating the industry, but some are already beginning to question its enforcement ability. The ASFA was even quoted as saying,
“The current structure and resourcing of ASIC limits its ability to influence industry, and the resultant criticism which ASIC receives in respect of delayed action can erode public confidence.”
With no robust facility to monitor the hundreds of thousands of loans being offered every year, consumer advocates are concerned that borrowers will continue to be exposed to improper lending. Currently, ASIC has been tasked with assessing the impact of a national, real-time database to monitor and track borrower and lender transactions (Consultation Paper 198: Review of the effectiveness of an online database for small-dollar lenders). This database would provide a valuable regulatory tool for the ASIC and it would help lenders to more accurately follow all of the new guidelines while ensuring 100% compliance of the proscriptive rules.
Canada’s RFI and progress
In 2006, the Canadian government set a national interest rate cap at 60% per annum, limited the size of payday loans to $1,500 and required that the loan period be less than 62 days. Individual provinces can be granted permission to set a higher per annum interest rate, if they seek to do so, by the federal government.
Since then, individual provinces have enacted a variety of responsible lending practices including:
- A two-day cooling off period, allowing borrowers to cancel the loan within 48 hours without paying any penalty
- A prohibition on rolling over loans
- Prohibiting more than one loan being issued to a consumer by the same company, at the same time
- Prohibiting “discounting”, where certain fees are included in the loan amount, resulting in the borrower receiving less than they intended on borrowing
While all of these regulations have greatly helped in regulating the small-dollar lending industry, there is still room for improvement. In November 2013, the Ontario Ministry of Consumer Finance began exploring the possibility of using a real-time database to assist regulators and lenders in monitoring and enforcement of the lending environment. Additionally, in early 2014, the Ministry clarified the type of loans that a licensee may offer to ensure small-dollar, high-cost loans are not disguised as a traditional installment loan. A decision is pending on whether a system will be implemented, but the Government is carefully weighing its options.
The Florida Plan
The State of Florida’s regulatory framework has been one of the most successful in the U.S., helping both lenders and consumers to form mutually beneficial relationships. At the heart of these regulations is a real-time internet-based database, which requires all lenders to check consumer eligibility before they are given a loan. This database only permits allowable amounts, rates, fees and terms to be used for transactions. The database also provides other compliance services to both lenders and consumers, helping each to evaluate and understand their decisions. It also helps regulators by detecting suspicious activities, mediating disputes and ensuring access to a payment grace period and credit counseling. The robust support environment includes a staffed call center that helps to detect unlicensed activity and lets consumers know their rights and protections under Florida law.
Florida policy-makers have found this database program especially attractive because it is entirely self-funded, and benefits both lenders and consumers. No State funds were utilized to start the program, and the industry maintains the program by paying a per-transaction fee.
- 40% growth in provider locations since the inception of program
- 9% annual rate of growth in payday loan transactions
- Loan loss has decreased to 1.6% of transactions conducted (Florida Trends of Deferred Presentment, May 2014)
Small-dollar, high-cost lending is a challenging sector of consumer finance to regulate because it is hard to find a balance between consumer and lender interests. Regulations that are too restrictive may result in an immediate fall-out in terms of available credit. Regulations that fail to address common issues with small-dollar, short-term lending expose consumers to a dangerous debt spiral and potentially significant financial burdens.
International jurisdictions could benefit greatly from the lessons learned in Florida, Michigan, and the twelve other U.S. jurisdictions using real-time regulatory databases that enforce consumer protections for over 80 million consumers. Jurisdictions may benefit from strong front-end controls, like the State of Florida, using real-time technology versus traditional oversight methods of examination on the back end of the lending cycle. Regulatory bodies and licensed lenders also benefit from this robust tool by ensuring compliance of the millions of loans conducted each year. Without consistent and thorough enforcement of balanced regulations, the small-dollar, high-cost lending industry will continue to face controversy.