Today at the CFPB’s field hearing on payday lending, the Bureau announced the publication of its Short-Term, Small-Dollar Lending Procedures – a field guide CFPB examiners will use to make sure payday lenders – banks and nonbanks – are following federal consumer financial laws.

“We recognize the need for emergency credit. At the same time, it is important that these products actually help consumers, rather than harm them,” said CFPB Director Richard Cordray in his opening remarks at today’s field hearing. “Now, the Bureau will be giving payday lenders much more attention.”

Here’s an excerpt from the Bureau’s announcement:

With the establishment of the CFPB, a federal agency for the first time can supervise not only bank payday lenders but also all nonbank payday lenders. Specifically, the Short-Term, Small Dollar Lending Procedures describe the types of information that the agency’s examiners will gather to evaluate payday lenders’ policies and procedures, assess whether lenders are in compliance with federal consumer financial  laws, and identify risks to consumers throughout the lending process.  The procedures track key payday lending activities, from initial advertisements and marketing to collection practices.

The CFPB will be implementing its payday lending supervision program based on its assessment of risks to consumers, including consideration of factors such as the volume of business and the extent of state oversight.  The CFPB also will be coordinating with federal and state partners to maximize supervisory capability and minimize regulatory burden.  If a violation of a federal consumer financial law has occurred, the CFPB will determine whether supervisory or enforcement actions are appropriate.

In general, CFPB supervision will include gathering reports from and conducting examinations of bank and nonbank activities.  The examination process will begin with scoping, review of information, and data analysis followed by onsite examinations.  The CFPB will be in regular communication with supervised entities, and it will conduct follow-up monitoring.

To download the Manual, click here.

Another great article from Felix Salmon at Reuters, discussing the differences between a credit union payday-like product and those offered by traditional payday lenders.  It’s probably one of the more level-headed approaches to explaining how the product works.

Just one excerpt from the article:

“…what payday lenders are really selling is convenience, at least as much as it is loans. Check cashers, payday lenders, and the like do not keep typical banking hours: they’re open late, they’re open at weekends, and they are generally found in small storefront locations which would not be suitable for a fully-fledged bank branch.

This is entirely rational — you want to be where your customers are, and you need to be able to reach your customers when they’re not working any of their jobs. But at the same time, it’s expensive. And in general, credit unions are already paying for the cost of their overheads, before they start offering any kind of payday loan. So while payday lenders have to cover a lot of overhead from the proceeds of just one product, credit unions have to cover just the marginal cost of the payday loans, which is a great deal smaller. After all, their staff and real estate is already being paid for.”

This story from Felix Salmon of Reuters discusses a short-term credit customers’ borrowing experience and that of her relationship with a credit union of 15 years. Interesting findings from him in the discussion of a borrower’s credit score:

Hal James (CEO of Missouri Credit Union) works on changing “poor management of money that they’ve got”. The credit union, he said, will “work to get the savings started”, rather than add more debt: “if you think that you have to borrow more money to improve your credit score, that’s not a solution. It’s not going to work.”

Sadly, James is wrong about this. The information going in to your credit score includes absolutely nothing about your salary, or your savings rate, or any of your assets. Let’s say that I defaulted on a lot of loans five years ago, which ended up being charged off; since then, I’ve avoided all credit, got a high-paying job, lived within my means, built up my savings — and inherited a million dollars to boot. What happens to my credit score? Very little. As the bad loans on my credit report drift ever further into the past, they will have a slightly less negative effect on my credit score. But without anything positive on there, my score will remain abysmally low indefinitely.

James told me that “you can go from 500 to the mid-600s if your bad credit drifts far enough behind you”. I checked this with FICO, and it’s just not true. Once you have a bad credit score, the only way you can make a significant improvement to it is to borrow money and pay it back.

As it pertains to access to credit, and why borrowers choose to go with short-term lending products, Salmon said this:

Is it a good idea for the professor to be taking out loans at 40% interest rates? Really, she didn’t have much of a choice. She needed the money, she got precious little help from her credit union, and the loan company was friendly and extended her the cash on terms she could afford.

What’s more, the professor’s relationship with World Finance has indeed improved her credit. Since taking out that first loan, she’s obtained two different credit cards, and also bought a brand-new BMW with 2.9% financing. All with essentially no help at all from her primary financial institution, which is Missouri Credit Union. The debt the professor is taking on may or may not be wise, given her unique individual circumstances. And the credit union could in theory be a valuable resource in terms of helping her work out whether, for instance, she can really afford that car. But the relationship there is broken, and I see no chance that it will be fixed.

Can you eliminate access to short-term credit like payday loans? A senior editor at The Atlantic doesn’t think so. Great excerpt below from the story:

Credit unions are not charities.  They have responsibilities to the members who deposit money with them: they cannot make loans that are reasonably likely to lose money (at least in aggregate).  And while the interest rates on products like payday loans are indeed eye-popping, the companies themselves are not especially profitable.  This suggests that the reason the loans are so expensive is that they cost a lot to make.

Why is this?  For starters, because the risk of default is very high.  It’s hard to get good numbers, and estimates vary widely, but I’m pretty sure that they’re well north of 10%.  That’s a pretty high default rate for any type of loan, but particularly one where the term is measured in weeks.

That’s not the only reason to think that these loans are expensive.  Since they are often for very small amounts, they have high transaction costs relative to the loan amount–it takes just as much time to process forms for a $200 loan as it does for a $10,000 loan.

There’s also the structure of the loan, which involves a lot of intensive interaction with the borrower.  Remember, the short term (and the fact that they’re tied to payday) helps hold down the default costs on payday loans.  It’s also really expensive to achieve; it means maintaining a storefront with people in it at all hours.