The Consumer Financial Protection Bureau (CFPB)’s long-anticipated rulemaking on small-dollar lending took a surprising turn. The version of the CFPB’s small-dollar regulation proposed in 2016 would have covered a wide array of small consumer loans, and was further accompanied by a request for information on additional small-dollar products and practices not covered by the proposal, all of which implied that the CFPB had a far-reaching agenda for regulating small-dollar consumer credit and, as a first salvo, would fire off a sweepingly broad small-dollar regulation. But that is not what has happened so far. Rather, the final rule, announced on October 5, is narrowly drawn and centers on more limited, specific types of short-term payday loans.

To be sure, the October 5 final rule is groundbreaking in a number of ways. Notably, it marks the first time that ability-to-repay requirements have been explicitly imposed at the federal level on short-term consumer loans of the type that are covered. It is also the first federal regulation explicitly restricting repeated attempts by lenders of such loans to withdraw payments from consumers’ accounts.

Of course, payday and other small and/or short-term consumer loans were already highly regulated at the state level. Indeed, they are some of the most highly regulated credit products, covered by a state-by-state patchwork of requirements regarding licensing of nonbank lenders, permissible fees and interest rates, disclosures, and other matters; several states have even outlawed payday and title loans. And some municipalities have also acted to limit or regulate such lending. Not all states have laws addressing the specific issues covered by the CFPB’s rule, however. Now, in whatever state the covered loan is made, lenders must follow the requirements set forth in the CFPB’s rule. (The rule does not address several issues that remain the province of state law, such as licensing requirements and substantive limits on interest rates and fees.)

What the Rule Does

Although more narrowly focused than its proposed version, the CFPB’s final payday rule is nonetheless quite detailed and imposes several new requirements.

(It may also be helpful to consult the CFPB’s summary of the rule.)

Different aspects of the rule apply to two types of covered loans. (And, as discussed below, certain types of loans that might otherwise be covered are excluded from the rule entirely.)

First, the rule has underwriting provisions that apply to many short-terms loans that have terms of 45 days or less, including vehicle title loans, as well as to many longer-term balloon-payment loans. These underwriting provisions generally require lenders to conduct what the CFPB calls a “full-payment test” to make a reasonable determination that the applicant would be able to make the payments on the loan and be able to meet the consumer’s basic living expenses and other major financial obligations without needing to re-borrow over the next 30 days. This test includes requirements to verify the consumer’s net monthly income, debt obligations, and housing costs, and to forecast a reasonable amount for basic living expenses. Lenders also must observe a mandatory “cooling-off” period: a lender is prohibited from making a covered short-term loan to a consumer who has already taken out three covered loans in which each loan is within 30 days of another covered loan; as to that borrower, the lender must wait 30 days after the third loan is no longer outstanding.

Alternatively, a lender may make a covered short-term loan without meeting these underwriting criteria if the loan meets certain specific terms, the lender confirms that the consumer meets specified borrowing history conditions, and the lender provides certain required disclosures to the consumer. For example, as described by the CFPB, “a lender is allowed to make up to three covered short-term loans in short succession, provided that the first loan has a principal amount no larger than $500, the second loan has a principal amount at least one-third smaller than the principal amount on the first loan, and the third loan has a principal amount at least two-thirds smaller than the principal amount on the first loan.” However, a lender is not permitted to take a non-purchase-money security interest in a vehicle in connection with loans made under this alternative approach. (Purchase money auto loans, as noted below, are excluded from the rule altogether.)

Second, certain parts of the rule also apply to other unsecured consumer loans with terms of more than 45 days that have (1) an APR exceeding 36 percent; and (2) a form of “leveraged payment mechanism” that gives the lender the right to withdraw payments from the consumer’s account, such as a checking account. For these loans, as well as the loans subject to the ability-to-pay requirements, the rule states that it is an unfair and abusive practice for a lender to attempt to withdraw payment from the consumer’s account after the lender’s second consecutive failed attempt due to a lack of sufficient funds, unless the lender obtains the consumer’s new and specific authorization to make further withdrawals.

This provision is notable for, among other things, defining an “abusive” practice by regulation. Seven years after being preliminarily defined in the Dodd-Frank Act, which gave the CFPB the authority to further elaborate on the definition, what is “abusive” remains somewhat nebulous. The CFPB has used the term less often than “unfair” or “deceptive,” and has generally defined “abusive” conduct through allegations in enforcement actions rather than by regulation.

These parts of the final rule will become effective 21 months after publication of the final rule in the Federal Register, which is expected soon. The rule also requires lenders to use credit reporting systems registered with the CFPB to report and obtain information on certain loans; those provisions will become effective 60 days after publication of the final rule in the Federal Register.

What the Rule Does Not Do

As mentioned above, the payday rule does not address some of the most hotly scrutinized issues in state law, such as permissible interest rates and fees. The CFPB lacks the authority to set interest rates and fees, and so that issue is left to state law. As the CFPB does not license entities, the states also will continue to run their own licensing regimes. And even where the CFPB’s rule addresses matters covered by state law, those state laws will be preempted only to the extent of any inconsistency with the rule. “Accordingly, the arguments advanced by some commenters that the payday rule would ‘occupy the field’ are incorrect,” the CFPB stated in the preamble to the final rule.

In contrast to what was expected from the proposed version, the final rule does not cover longer-term installment loans, even though those loans may share some features with loans that are covered, such as high APR and lack of underwriting. The final rule also excludes (1) loans extended solely to finance the purchase of a car or other consumer good in which the good secures the loan; (2) home mortgages and other loans secured by real property or a dwelling if recorded or perfected; (3) credit cards; (4) student loans; (5) non-recourse pawn loans; (6) overdraft services and lines of credit; (7) wage advance programs; (8) no-cost advances; (9) alternative loans that are similar to loans made under the Payday Alternative Loan program administered by the National Credit Union Administration (NCUA); and (10) accommodation loans.

It would be premature to conclude that the CFPB will not regulate longer-term installment or other small-dollar loans in the future. The CFPB may want to observe how the payday rule works in practice before deciding which, if any, of its requirements to impose on other loans. And the CFPB’s rhetoric around this rule, and small-dollar credit generally, indicates that the CFPB has strong concerns about consumer loans with high APRs, in particular those that do not involve analysis of the applicant’s ability to repay and could “trap” consumers in a cycle of debt they cannot repay. In prepared remarks about the final payday rule, CFPB Director Richard Cordray emphasized that the “rule is guided by the basic principle of requiring lenders to determine upfront whether people can afford to repay their loans,” as well as limiting lenders’ ability to repeatedly try to access borrowers’ accounts to obtain payment when those accounts did not have sufficient funds for repayment.

Any type of loan that appears to pose such risks could potentially attract the CFPB’s attention going forward.

What to Expect from the Other Federal Banking Regulators

The CFPB’s concerns about small consumer loans echo many of those long expressed by other federal banking regulators—though recent leadership changes at the Office of the Comptroller of the Currency (OCC) make it less certain what the OCC’s approach will be going forward.

The federal banking regulators have historically had a somewhat complex relationship with small-dollar consumer credit. On the one hand, the agencies have affirmatively encouraged banks and credit unions to provide small-dollar credit as a potentially more consumer-friendly substitute for alternative financial services (AFS) such as payday lending, pawnshops, and check cashing services. The FDIC, in particular, has actively encouraged banks to offer small credit, such as through its Small-Dollar Loan Pilot and its 2007 Affordable Small-Dollar Loan Guidelines, believing that such loans could bring underserved consumers into the financial mainstream and keep them there rather than seeking out AFS when they need small, short-term loans. The agencies have also noted that banks may receive favorable Community Reinvestment Act (CRA) consideration for small-dollar lending programs.

At the same time, the FDIC and the other agencies have also cautioned their supervised institutions about concerns associated with one type of small consumer loan in particular: deposit advance products (DAP).

DAPs are short-term advances to bank depositors that are meant to be repaid out of the customer’s next direct deposit. The FDIC and OCC issued guidance in 2013 warning banks about supervisory concerns associated with DAP, including potential credit, reputation, operational and compliance risks, informed by the CFPB’s 2013 white paper on payday and DAP. Also in 2013, the Federal Reserve issued a much briefer “Statement on Deposit Advance Products” that “emphasize[d] to state member banks the significant consumer risks associated with deposit advance products in light of the Consumer Financial Protection Bureau’s (CFPB) April 24, 2013 white paper[.]” The FDIC and OCC issuances in particular went into detail about several potential concerns, some of which relate to concerns raised by the CFPB in its payday rulemaking. For instance, the FDIC and OCC cautioned that banks should conduct underwriting for DAP loans, including eligibility criteria “designed to assure that the extension of credit, including all associated fees and expenses, can be repaid according to its terms while allowing the customer to continue to meet typical recurring and other necessary expenses such as food, housing, transportation, and healthcare, as well as other outstanding debt obligations.” Further, the FDIC and OCC warned against facilitating consumers’ use of DAP as anything more than an infrequent solution to short-term credit needs: “Additionally, criteria should ensure that customers can meet these requirements without needing to borrow repeatedly…. Deposit advance loans that have been accessed repeatedly or for extended periods of time could be evidence of inability to repay and inadequate underwriting. A bank should monitor for repeated or extended use[.]”

DAPs would be covered by the CFPB payday rule if they otherwise have the features of covered loans as described in the rule. While the rule carves out loans akin to those made under the NCUA’s Payday Alternative Loan program, the rule does not give a blanket exemption to all credit simply because it is extended by banks or credit unions.

Noting this, shortly after the CFPB’s payday rule issuance, the Office of the Comptroller of the Currency (OCC) rescinded, through its Acting Comptroller Keith Noreika, its DAP guidance, stating, “Since adoption of the Guidance in 2013, the regulatory and marketplace landscapes have changed, and the OCC has gained supervisory experience with application of the Guidance to deposit advance products” and that the CFPB’s payday regulation “overlaps with the Guidance and will therefore apply to many of the loans addressed by the Guidance” and the two could potentially be inconsistent in the way they treat underwriting expectations and cooling-off periods. However, as of this writing, neither the FDIC nor the Federal Reserve had rescinded their DAP issuances.

Banks offering DAP or any other small-dollar or short-term consumer credit should therefore keep an eye on the federal banking regulators, as well as the CFPB, for further action regarding such loans. It is unclear exactly what changes the OCC may make to its supervisory approach under its new leadership (whether under this Acting Comptroller or a permanent one, who has yet to be confirmed). Nominees for key posts at the FDIC and Federal Reserve are expected in the future as well.

Nonbank lenders should continue to monitor the CFPB’s activities, as the agency could propose further rules covering additional types of small-dollar credit. In addition, it will be important to stay aware of the activities of state and local authorities, in particular regarding any additional steps they may take to further regulate loans not covered by the CFPB’s final payday rule.