SMALL DOLLAR LOANS IN THE SPOTLIGHT
Payday lending continues to draw attention as Congress and the banking agencies consider small dollar loans, concerns about borrowers in the military and credit card lending.
FDIC ISSUES DRAFT GUIDELINES
On December 4, 2006, the Federal Deposit Insurance Corporation issued draft guidelines to state non-member banks encouraging them to offer small-dollar loans that are affordable, yet safe and sound. The FDIC indicated that a bank offering such loans in a manner that is consistent with the guidelines would warrant favorable consideration under the Community Reinvestment Act as an activity responsive to the credit needs of the community. As part of the guidelines, the FDIC encourages banks to do the following:
- Offer loans with fees and interest rates that reflect associated risks, but remain affordable. In regard to fees, the FDIC indicated that banks may impose origination fees that bear a direct relationship to origination costs; however, annual fees, membership fees, advance fees, prepayment penalties and other fees that may prevent borrowers from reducing outstanding principal are discouraged. In regard to interest rates, the FDIC encourages banks to limit the annual percentage rates on loans to 36% or less (this 36% APR limitation is similar to the limitation protecting covered servicemembers and their dependents that was recently enacted as part of the John Warner National Defense Authorization Act for Fiscal Year 2007 [see New Military Protections below]);
- Offer payment programs that foster the reduction of principal owed;
- Adopt underwriting criteria that focus on a borrower’s ability to repay a loan;
- Rely on information that banks already have on existing customers in order to process applications quickly and assist borrowers with little or no credit history;
- Rely on existing technology and automated processes (e.g., automated telephone systems, in-branch automated underwriting and online applications) in order to provide quick and inexpensive service;
- Structure small-dollar loans to include a savings component;
- Collaborate with other financial institutions or organizations in order to develop and implement a loan program for the bank’s community; and
- Educate borrowers on financial matters, particularly when signs of financial stress are detected.
Comments on these guidelines will be accepted for 60 days.
NEW MILITARY PROTECTIONS
On October 16, 2006, Congress enacted new credit protections for military personnel and their dependents by an amendment to General Military Law. The new provisions are separate from and independent of the familiar Servicemembers Civil Relief Act (formerly known as the Soldiers’ and Sailors’ Civil Relief Act of 1940). The new credit protection provisions prohibit creditors from imposing an APR greater than thirty-six percent (36%) with respect to consumer credit (excluding residential mortgages and certain other loans secured by personal property or motor vehicles) extended to a member of the armed forces on active duty or on active Guard or Reserve duty.
The APR provision is meant to restrict payday lending to the military, requires that a creditor disclose in writing the APR applicable to the extension of credit, comply with the disclosure provisions of the Truth in Lending Act, and give a clear description of the payment obligations. Under the new provisions, it is unlawful for a creditor to do any of the following:
- Roll over, renew, repay, refinance or consolidate any consumer credit extended to the borrower by the same creditor with the proceeds of other credit extended to the same covered member or dependent;
- Require the borrower to waive the right to legal recourse under State or Federal law;
- Require the borrower to submit to arbitration or impose onerous legal notice provisions in the case of a dispute;
- Demand unreasonable notice from the borrower as a condition for legal action;
- Use a check or other method of access to a deposit, savings, or other financial account maintained by the borrower, or the title of a vehicle, as security for the obligation;
- Require, as a condition for the extension of credit, that the borrower establish an allotment to repay an obligation; or
- Prohibit the borrower from prepaying the loan or charge a penalty fee for prepaying all or part of the loan.
The Secretary of Defense is directed to prescribe regulations in consultation with the federal banking agencies, the Federal Trade Commission and the Treasury Department to establish:
- Disclosures required of any creditor that extends consumer credit to a covered member or dependent of such a member;
- The method for calculating the applicable annual percentage rate of interest on covered obligations in accordance with the 36% APR limit;
- A maximum allowable amount of all fees and the types of fees, associated with covered extensions of credit, to be expressed and disclosed to the borrower (as a total amount and as a percentage of the principal amount of the obligation) at the time at which the transaction is entered into;
- Relevant definitions; and
- Such other criteria or limitations as the Secretary of Defense determines appropriate, consistent with the new provisions.
The new provisions will have only prospective effect and are not scheduled to take effect until October 1, 2007. However, the Secretary of Defense is permitted to prescribe interim regulations and set an earlier effective date.
While the impact of recent elections and final agendas are fluid, the House Financial Services Committee has planned hearings to consider revising the new military credit provisions in response to complaints by bankers who fear that the amendment could adversely affect credit card programs. How intently the House or Senate may work to make changes in the military credit provisions or to create new legislation is unclear. Senator Dodd and Representative Frank have both expressed strong sentiments against credit practices perceived as “abusive” but have also indicated support for credit cards in general and essential small loan credit in particular. Representative Frank’s personal interest in affordable housing, among other issues before both the House and Senate, may indicate that there will be more talk of change than substantive legislation. Nonetheless, both the FDIC and the House Committee have indicated, for example, that they hope to work with lending institutions to develop profitable short-term loan programs. Different elements of the industry may be held up for approval, challenge or criticism in an effort to bring about change in a “collaborative” way that leaves the industry searching for concrete guidance and facing undeterminable risks.
Michael Tomkies, Charles Gall and Kathleen Manley