Direct from Richmond, Virginia: yesterday, I (Travis) visited the Greater Richmond Convention Center, where the Consumer Financial Protection Bureau (CFPB) announced at a field hearing a sweeping proposal for new rules regarding payday/deposit advance loans, auto title loans, and certain high-interest, longer-term loans. (A Fact Sheet summary is here.) After CFPB Director Richard Cordray outlined the CFPB’s proposal, the Bureau heard from, first, a panel of industry and consumer advocates and, then, members of the public. The hearing was packed and the audience ̶ comprised of payday lender employees, consumer advocates, and others ̶ lively, with one or another of those groups applauding after nearly every person’s turn at the microphone.

Leveling the short-term lending playing field between banks, credit unions and payday lenders The CFPB proposal may present an opportunity for banks because it will level the short-term loan playing field between banks, credit unions (CUs), and payday lenders. Under current law, banks have been at a major disadvantage to their nonbank payday competitors because banks have to follow regulatory guidance that does not apply to nonbanks. As a result, most banks have exited the short-term loan business. If the CFPB goes forward with its proposal, banks may have a chance to get back into short-term lending and capture some of the estimated $12 billion in interest and fees that consumers pay each year for payday and auto title loans.

Under the proposal, banks and CUs stand to benefit because their payday competitors will see their margins reduced by added costs and reduced profits. The proposal would require a verification of ability to repay for every loan origination, including rollovers: “For each loan, lenders would have to verify the consumer’s income, major financial obligations, and borrowing history to determine whether there is enough money left to repay the loan after covering other major financial obligations and living expenses.” This is a major change from the status quo, in which many payday lenders only verify income but do not consider other expenses.

This aspect of the proposal will be less burdensome on banks and CUs than on payday lenders because banks and CUs have traditionally verified their customers’ ability to repay their loans. Moreover, because banks and CUs have a real-time window into customers’ cash flows in the form of account data, they can verify their customers’ ability to repay more easily than a payday lender can.

In the face of these heightened regulatory requirements, some payday lenders may choose to exit the market, and those that remain will be forced to substantially alter their products. The level playing field may also impact consumer behavior. Faced with requests for more documents from their local payday lenders, consumers may find it as convenient, or perhaps even more convenient, to borrow from their bank or CU instead.

Options for lenders: prevention versus protection The CFPB’s proposal would give lenders the choice of complying with one of two sets of requirements: “prevention” or “protection.” The prevention framework would require an upfront analysis of a consumer’s ability to repay the loan. The protection framework would require less upfront work but would limit the loan’s terms to make it easier for consumers to repay. Assuming the rule is finalized with this prevention/protection dichotomy, lenders will have a choice to make: whether to offer consumers two types of loans, or to offer only one or the other.

For short-term loans (repayable in 45 days or fewer), some payday lenders may opt for the “protection” framework (which the proposal limits to unsecured loans that do not exceed $500) because they do not wish to take on the responsibility – and potential liability – of the ability-to-repay analysis. Some payday lenders will offer loans under both frameworks because they will want to offer loans larger than $500 and/or to take a security interest in their customers’ automobiles.

For longer-term loans (repayable in more than 45 days), the CFPB is proposing two possible approaches for the “protection framework”: (1) a 28 percent interest rate cap, $1,000 principal limit, $20 application fee limit, and no more than two loans in six months; or (2) a 5 percent limit for the payment-to-income ratio. Given these limits, it seems likely that most payday lenders that make longer-term loans will choose the “prevention” option. This means more work up front, but it will not curtail profits as much as the limits on interest or payment size.

Industry representatives and consumer advocates talking past each other Yesterday’s field hearing illustrated the vast gulf between the positions of the industry and the consumer advocates. In the panel session, industry group participants – with the exception of the CU representative, who contended that credit unions already meet the proposed standards – expressed grave concerns both with the proposal and rhetoric of the CFPB. Consumer advocates generally praised the proposal, although some said it does not go far enough. After the panel session, dozens of members of the public spoke for a minute each. The speakers alternated between two distinct groups: (1) payday lender employees talking about how proud they are of their work and the emergency situations with which they help their customers, and (2) consumer advocates and religious leaders describing the harm to consumers that they see from payday loans.

Obama threatens to veto bill that would weaken CFPB Also yesterday, President Obama gave a speech in which he praised the CFPB’s payday proposal. He also said the Republican budget would make it harder for the CFPB to do its job, and he reiterated his threat to veto any bill that unravels Wall Street reform.

Procedural posture The CFPB has not yet issued a formal proposed rule. Before it does so, it will convene a Small Business Review Panel to gather feedback from small lenders. Separate and apart from the notice-and-comment procedures under the Administrative Procedures Act, the Consumer Financial Protection Act requires that, when the CFPB is developing a rule that may have a significant economic impact on a substantial number of small entities, the CFPB must convene a panel consisting of representatives from the CFPB, the Small Business Administration, and the Office of Management and Budget’s Office of Information and Regulatory Affairs. In the coming weeks, the panel will have an outreach meeting with representatives of small businesses to receive feedback on the potential economic impacts of the proposed regulations and alternatives