WASHINGTON—The Obama administration will announce Thursday the federal government's first move to regulate high-interest, low-dollar "payday loans," a $ 38.5 billion market currently left to the states.
The crackdown on the payday industry—largely storefront lenders extending credit to 12 million lower-income households paycheck to paycheck—follows a series of actions by President Barack Obama and his aides to cement a change in the balance of power between consumers and financial institutions during their last year in office.
The payday rule, proposed by the Consumer Financial Protection Bureau, imposes a complex set of requirements on the payday industry, mandating that lenders assess a borrower's ability to repay and making it harder for lenders to roll over loans—a practice that often leads to escalating borrowing fees—or to take fees out of a borrower's bank account.
The payday rule comes a month after the CFPB finalized a proposal to make it easier for consumers to file class-action lawsuits against financial institutions, by barring mandatory arbitration. A month before that, the Labor Department announced a plan to overhaul retirement-savings advice, stoking ire from the industry and prompting a lawsuit this week from big-business trade groups seeking to overturn the measure.
The CFPB plans to roll out in the coming months new rules governing prepaid cards, bank overdraft fees and debt collection. The agency indicated in this week's payday announcement that still more rules are coming for that sector, saying it was "launching an inquiry into other potentially high-risk loan products and practices that are not specifically covered by the proposed rule."
The five-year-old agency's expansive interpretation of its post-financial-crisis mandate to impose federal oversight on lightly regulated corners of American finance has been cheered by consumer groups and Democrats. But that has prompted multiple legal challenges from the industry complaining of overreach and a backlash from Republicans vowing to rein it in if they win November's elections.
In this week's new edict on payday loans, the CFPB seeks to overhaul the corner of the financial market largely abandoned by banks, where borrowers take out short-term loans of a few hundred dollars, paying effective annual interest rates over 300%. Vehicle-title loans and certain types of installment loans also would be targeted.
The proposal will be formally unveiled at a meeting Thursday in Kansas City, Mo., attended by representatives of consumer groups and the industry. The rule will go through a 90-day public comment period, with a formal rollout expected early next year.
Payday lenders have long opposed the pending rule, saying it would force many out of business and leave low-income borrowers without much-needed credit. As part of the 2010 postcrisis financial overhaul law, Congress told the CFPB to "regulate payday, not annihilate it—and so much of what they are proposing represents an annihilation," said Dennis Shaul, chief executive of the Community Financial Services Association of America, the primary industry group of payday lenders.
Rule opponents argue that the new limits would hurt the vulnerable borrowers they intend to protect. They cite a January survey by Bankrate.com showing that only 37% of adult Americans have the necessary savings to cover a $ 500 car repair or a $ 1,000 emergency-room bill.
Some advocates of new federal curbs on payday lending also criticized the rules, saying the complexity and tight strings would discourage banks and others from entering the market, possibly leaving a void. At 1,549 pages, the payday rule is nearly twice as long as the CFPB's 804-page mortgage regulation issued in 2013 in response to preventing another mortgage crisis.
"The CFPB proposal misses the mark," said Nick Bourke, director of small-dollar loan research at the Pew Charitable Trusts, who was briefed on the proposal. He said the rules effectively lock out small-dollar loans from banks.
The CFPB rule is the second big blow to the industry this year, following a decision by Google Inc. last month to ban online ads from payday lenders on the dominant search engine.
Congress prohibited the CFPB from setting a direct interest-rate cap for federal rules. So the agency's regulation seeks to change lending practices by other means.
Under the new rules, the CFPB imposes a series of "full payment tests" on lenders, customized to different types of loans, requiring the firms to do extensive due diligence to see if borrowers can repay their loans. Currently, few payday lenders do such underwriting, saying it is too costly.
Lenders would be required to go through another review of borrowers' finances if the borrower seeks to renew or extend the loan.
During the first few years of its existence, the CFPB's rule-making efforts were focused on sectors like mortgages and credit cards, where the bureau had been given a clear mandate by Congress.
But the agency has been moving into areas where its authority is more nuanced, creating more friction with industry. To regulate payday lending, the bureau is for the first time relying on its authority to prohibit "unfair, deceptive, or abusive acts and practices," according to Gerald Sachs, counsel at Paul Hastings and a former enforcement lawyer at the CFPB.
Company officials and lawyers have complained that authority—known as Udaap—is overly broad and could make the bureau's actions unpredictable.
"Too many borrowers seeking a short-term cash fix are saddled with loans they cannot afford and sink into long-term debt," CFPB Director Richard Cordray said in a statement released to reporters Wednesday. "It's much like getting into a taxi just to ride across town and finding yourself stuck in a ruinously expensive cross-country journey."
—Rachel Witkowski contributed to this article.
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