DIEGO ZULUAGA, CATO INSTITUTE
The Consumer Financial Protection Bureau has been controversial since its creation. As an executive agency enjoying Federal Reserve funding independent of the Congressional appropriations process—and run by a single director removable only for cause—the Bureau is unusual and possibly unconstitutional. In its first years of existence, the CFPB gained a reputation for its exceptional activism and anti-industry agenda. Curiously, many of its enforcement and rulemaking activities focused on areas that were explicitly outside of its regulatory remit—such as auto lending, federal student loans, and credit providers historically regulated at the state level, such as payday lenders.
When Mick Mulvaney replaced Richard Cordray as CFPB Director, he vowed to stop “pushing the envelope” in its approach to regulation. Progressive fans of the Bureau took this as a sign that Mulvaney would terminate the CFPB’s enforcement activities altogether, an expectation that subsequent developments belie. Still, the financial industry, wary of the Bureau’s exceptional powers, breathed a sigh of relief that the Cordray-era modus operandi of attempting to change industry practices, even legal ones, through threats of lengthy and expensive enforcement actions might be over.
Now Mulvaney’s replacement Kathy Kraninger has the unenviable task of crafting a policy agenda for the CFPB that raises consumer welfare and promotes choice, competition, and innovation in the provision of credit. To assure regulatory certainty, her agenda should fall within the Bureau’s regulatory mandate and be compatible with the rule of law. Kraninger will undertake her task in the face of both Democrat hostility and Republican skepticism that the Bureau should even exist. Added to that, designing effective policy changes will also require Kraninger to keep current CFPB staff motivated and to recruit new economists and lawyers who share her vision.
Despite the challenges, Kraninger’s tenure has started auspiciously. The CFPB’s new Office of Innovation is launching a regulatory “sandbox”—an approach that has delivered moderately successful results in Britain and Singapore—and a revised no-action letter policy. Both may make it easier for lenders to try out new ways of providing financial services. Furthermore, the Bureau intends to create an Office of Cost-Benefit Analysis, which could improve the rulemaking process in addition to serving as a gesture of goodwill toward the consumer credit industry—which the CFPB has long seemed to view as all cost and no benefit.
As Director Kraninger settles into her new role, here are five concrete, positive steps she can take to increase the credit options available to consumers.
1. Make it clear that the Bureau won’t suppress small-dollar loans.
In 2013, the Office of the Comptroller of the Currency (OCC) published guidance effectively directing depository institutions to stop offering deposit-advance products. These were short-term credit products offered to bank depositors. Only a handful of banks offered these short-term loans at the time, but the OCC’s stern admonition caused them to beat a hasty retreat. At best, the regulator’s actions moved small-dollar borrowers to the payday lending market; at worst, they cut off households’ access to short-term credit altogether.
The OCC has since rescinded its guidance. Indeed, regulators have made a U-turn, with the FDIC now aiming to encourage banks to offer more small-dollar credit products as a competitor to payday loans. Some have begun to re-enter the market, including U.S. Bank, which last year launched its Simple Loan. But most are wary of heeding the FDIC’s call, lest the pro-competitive drive of recent appointees end when a new administration names different financial regulators.
As the agency in charge of preventing unfair, deceptive, and abusive acts and practices (UDAAP) in the consumer financial sector, the CFPB already plays a vital role in creating a secure environment for competition and innovation. It could do so even more effectively by releasing its own guidance protecting small-dollar products in compliance with existing regulations from becoming the target of new enforcement actions. The Bureau should also encourage banks to request no-action letters for proposed small-dollar products. In doing so, Kraninger’s CFPB will not only reassure lenders, but her intellectual leadership will serve to guide other agencies that defer to the Bureau on matters of consumer protection.
2. Publish the CFPB’s econometric methods for evaluating fair lending compliance.
A particularly embarrassing moment during Cordray’s directorship occurred when the House Financial Services Committee released a report on the CFPB’s assessments of “indirect” auto lenders’—that is, dealers’ creditor partners’—compliance with fair lending rules. These are the regulations stemming from the 1974 Equal Credit Opportunity Act (ECOA), which bans racial and other forms of discrimination in lending when such discrimination is unrelated to the borrower’s creditworthiness.
The House Committee’s report uncovered evidence that the Bureau had set out to castigate auto lenders even before research revealed any wrongdoing. The empirical results followed the CFPB’s predetermined conclusion, which is the opposite of the way that good enforcement should work. Indeed, the econometric analysis that allegedly confirmed auto lenders’ discriminatory practices wouldn’t pass muster in an undergraduate module, ignoring as it did key factors such as a borrower’s income and existing debt burden.
To avoid future instances of such sloppy analysis, Kraninger’s CFPB should commit to publishing a detailed outline of the methods that it plans to use in evaluating fair lending cases. This will make compliance easier and allow independent analysts to compare the Bureau’s evaluation with their own. Publishing the CFPB’s analytical framework needn’t tie the Bureau’s hand in cases where alternative assessment methods might be appropriate. But it would place the onus on the CFPB to show which alternatives it had employed, and why.
3. Conduct a cost-benefit analysis of BSA-related regulations in consumer payments.
The CFPB regulates domestic and international electronic fund transfers, such as those made via Western Union, for consumer protection. Since 2013, it has regulated remittances–-international money transfers—by mandating that they disclose the exchange rate and foreign-currency amount of transactions to customers before completing any transfer of funds. According to the Bureau’s five-year assessment report, this rule placed an initial compliance burden between $86 million and $92 million, with ongoing costs of up to $102 million, on remittance providers.
The CFPB should conduct a comprehensive review of the regulatory costs its mandates place on remittance providers. That should include the cost of compliance with Bank Secrecy Act (BSA)-related regulations, which aim to tackle money-laundering and other illicit financial activities. The BSA is in fact the most onerous financial regulation for community banks, and defensive BSA reporting imposes significant regulatory costs for questionable national security benefit.
While illicit finance laws are outside the CFPB’s remit, its review should consider how BSA compliance costs might adversely affect low-income, minority, and immigrant communities’ access to banking and remittance services. These groups are particularly likely to use remittance services to send money abroad, and even though the nominal BSA thresholds for transactions are high, defensive reporting encourages financial institutions to flag up transfers far below the statutory limit, especially for funds transferred into or out of the United States.
Regressive regulation remains one of the toughest barriers to access and choice in financial services, especially for the communities who need it most. Director Kraninger should use her tenure at the CFPB to tackle these impediments head-on.
4. Facilitate the emergence of a federal market for fintech loans.
A growing share of consumer credit, and especially of credit going to minority and low-and-moderate-income (LMI) borrowers, comes from nonbank lenders. Many of these lenders are relatively new providers that use credit-scoring technology to improve underwriting in a way that makes credit more available and less expensive, while also reducing borrower default rates.
But regulatory uncertainty is holding back further growth in innovative lending. The 2016 Madden v. Midland decision overturned the long-standing valid-when-made principle, whereby loans made lawfully by a bank remain lawful when sold to a third party. The Court’s decision has already resulted in a decline in credit availability and a rise in personal bankruptcies. Given the ruling’s inconsistency with legal precedent and the Supreme Court’s refusal to take up the case, it seems that only legislative action codifying the valid-when-made principle, for banks and nonbanks alike, will permanently settle the issue. The OCC’s new fintech charter also offers protection from Madden, but take-up has been slow owing to pending state lawsuits.
In the meantime, however, the CFPB, which regulates fintech lenders, banks with assets above $10 billion, and debt collectors, should make it clear that it will not launch UDAAP enforcement actions against regulated institutions that purchase loans from banks in states subject to the Madden ruling. Through this commitment, Kraninger’s CFPB will facilitate the emergence of a liquid national market for consumer credit. This, in turn, will encourage competition and increase the financial inclusion of low-income consumers—a goal with which neither progressives nor free-marketeers should take issue.
5. Conduct a review of the regulatory barriers to nationwide mobile money accounts.
Despite a gradual reduction in the number of U.S. households without even a basic bank account, 6.5 percent (8.4 million families) remain unbanked. Some politicians have suggested postal banking as a way to reach these households. But that solution misunderstands the problem: most unbanked households do not lack nearby bank branches, but rather find the accounts on offer prohibitively expensive. They also tend to distrust financial institutions more generally. Survey findings from the FDIC echo University of Pennsylvania urban development professor Lisa Servon’s argument that many unbanked Americans—typically immigrant, minority, and low-income—find banks slow and opaque, and as a result often prefer so-called alternative providers: check cashers, payday lenders, and others.
Elsewhere in the world, unbanked rates have recently plummeted thanks to the spread of mobile money accounts (MMAs). Kenya’s M-Pesa is the best example, with its model having spread to other African countries, Latin America, and Asia. Safaricom, a telecommunications company, operates M-Pesa, taking advantage of Kenya’s widespread cell phone ownership. Adoption has been rapid because the Kenyan government allowed Safaricom to open customer accounts without a banking license. The government also helped by waiving some AML/ KYC regulations for low-value—and thus low-risk—customer accounts.
The Bureau should ask how it might facilitate the provision of mobile money accounts. 81 percent of Americans own a smartphone, and another 13 percent own a more basic cell phone. Allowing providers familiar to unbanked but “wired” Americans to offer these populations money transmission and other basic banking services might help unbanked communities overcome their distrust of traditional financial institutions and save them the account maintenance costs associated with traditional banking services.
The steps proposed here will allow Director Kraninger’s Bureau to play a major role in shaping the future of the U.S. market for consumer financial services—one that promotes innovation and competition. Instead of pitting consumers against financial services providers, and those providers against regulators, this agenda recognizes that a competitive environment and regulatory certainty can support a marketplace in which providers have strong incentives to adequately serve and protect consumers. The CFPB can achieve that without “pushing the envelope.” What’s not to like?
Diego Zuluaga is a policy analyst at the Cato Institute’s Center for Monetary and Financial Alternatives, where he covers financial technology and consumer credit. Before joining Cato, Zuluaga was Head of Financial Services and Tech Policy at the Institute of Economic Affairs in London. While at the IEA, he authored papers on the social value of finance, the regulation of online platforms, and the taxation of capital income, among others. His work has been featured in print and broadcast media, such as the Times, Newsweek, and the Daily Telegraph. Zuluaga is a prolific public speaker as well as a former lecturer in economics at the University of Buckingham. Originally from Bilbao in northern Spain, Zuluaga holds a BA in economics and history from McGill University, and an MSc in financial economics from the University of Oxford.