Payday Loans: Federal Regulatory Initiatives

CRS Report for Congress
Payday Loans:
Federal Regulatory Initiatives
Pauline Smale
Economic Analyst
Government and Finance Division
Summary
A payday loan arrangement permits an individual to use a personal check to get a
small, short-term, cash advance. The loans are typically for $100-$500. The borrower
writes a postdated check for the loan amount and a fee. The lender holds the check until
the borrower’s next payday, usually two weeks. This source of short-term credit can be
expensive. The fee charged on a 14-day payday loan is typically $15 to $17 per $100
advanced, amounts equivalent to an APR (annual percentage rate) of between 391% and

443%. A loan can become even more expensive if it is rolled over or extended.

State laws have generally governed payday lending; some are silent while others
have prohibited or restricted payday lenders. Payday loans are subject to the disclosure
provisions of the federal Truth-In-Lending Act. When payday lenders attempted to
partner with banks and thrifts to circumvent restrictive state laws, however, federal
regulators issued supervisory guidance relating to payday loans. Depository institutions
were cautioned that these arrangements introduced financial, compliance, and reputation
risks. Consumer advocates are concerned that these guidelines may not provide
sufficient consumer protection. They have called on Congress to examine the activities
of payday lenders to see if reforms are needed to protect consumers. In the 109^th
Congress, several bills (S. 1878, H.R. 1643, H.R. 1660, H.R. 4866, and H.R. 5350) have
been introduced with provisions addressing the regulation of payday lending. This
report provides information on the practice of payday lending and an overview of federal
regulation and legislation. This report will be updated as events and legislation warrant.
Background
The payday loan industry became a popular source of funds for cash-strapped
borrowers in the 1990s. Payday loans were originally offered through check cashing
outlets and pawnshops. The market for this financial product soon produced stand-alone
payday loan businesses. Today the industry includes large regional or national payday
loan businesses. Some providers are multi-service, offering a range of financial services
(for example, money orders and check cashing) as well as payday loans. Nationwide,
payday loan offices increased from approximately 300 in 1992, 10,000 in 2000, to almost

Congressional Research Service ˜ The Library of Congress

22,000 in 2003. The total dollar volume of payday loans in 2003 was approximately $40
billion.¹
In a payday loan transaction, the lender makes a small advance (typically $100-$500)
to its customer, agreeing to hold a personal check for the loan amount plus a fee until the
customer’s next payday. Sometimes the advance is made in exchange for the
authorization to debit electronically the customer’s checking account for the loan amount
plus the fee. The borrower receives cash immediately. Fees charged can range from $15
to $30 on each $100 advanced,² although the typical fee is at the lower end of that range.
The fee may seem modest when presented as a dollar amount, but when calculated as an
annual percentage rate (APR),³ the cost is relatively high. A charge of $15 to borrow
$100 for 14 days amounts to an APR of 391%. A survey by consumer advocates found
APRs on 14-day payday loans ranging from 390% to 871%.⁴
A loan can become even more expensive for the borrower who does not have the
funds to repay the loan at the end of two weeks and obtains a rollover or loan extension.
An additional fee is attached each time the loan is extended through a rollover transaction.
If a payday loan of $100 for 14 days with a fee of $15 were rolled over three times, it
would cost the borrower $60 to borrow $100 for 56 days. While this is still an APR of
391%, this example demonstrates how the loan fees can quickly mount and could
eventually become greater than the amount actually borrowed. Consumers can also
become trapped in back-to-back transactions. In these cases, the customer pays off the
first loan but immediately borrows again to meet financial needs. If the borrower defaults
on the loan, serious financial consequences can occur. The lender can deposit the
customer’s personal check which would result in additional fees (from the bank) for
insufficient funds if it did not clear the borrower’s checking account and could result in
the consumer being identified as a writer of bad checks.
Payday lenders found a significant demand for these small loans from customers who
found themselves unable to meet their current living expenses. These borrowers would
have personal checking accounts but no “cushion” of savings to meet unexpected
expenses or financial emergencies. In addition, they might not have easy access to credit
elsewhere; for example they may not qualify for a low interest credit card or they may
have found that their bank does not offer loans for small amounts of credit. Payday
lenders do not check a borrower’s credit history or look into his or her ability to repay the
loan. They only require identification, proof of income, and ownership of a checking
account.
Critics of payday lenders consider payday loans to be abusive in their terms and in
relation to a borrower’s ability to pay. Consumer advocates argue that the industry targets
vulnerable consumers, that the practice encourages chronic borrowing, and that frequent

¹ “Fast Cash is Gaining Currency,” The Dallas Morning News, Jan. 4, 2005.
² No Cash ‘til Payday: The Payday Lending Industry, Federal Reserve Bank of Philadelphia-
Supervision, Regulation, and Credit, First Quarter 2002, p.2.
³ The APR is a standard measurement of cost of credit to a borrower.
⁴ Show Me The Money: A Survey of Payday Lenders, State Public Interest Groups (PIRGs) and
the Consumer Federation of America, Feb. 2000, p.1.

users can become trapped in a cycle of expensive debt. Proponents state that payday loans
are meeting a need for short-term or emergency credit that is not being met by traditional
financial institutions. They argue that payday loan fees can be less costly than bounced
checks or credit card late fees and interest charges.
In general, state laws govern payday lending. State laws are not uniform in their
treatment of payday lending. Currently, 10 states do not have specific payday lending
legislation or are unfavorable to the industry because of interest rate ceilings. The
remaining 40 states and the District of Columbia have laws that address payday lending
most of which both limit finance charges and set a maximum loan amount.⁵ Some payday
lenders sought arrangements or partnerships with banks and thrifts⁶ that might allow them
to circumvent state restrictions or prohibitions. Consumer advocates spoke out against
this practice, calling it rent-a-bank payday lending.
A trade association for the payday loan industry created a set of standards for its
membership. The Community Financial Services Association of America (CFSA)
adopted a set of guidelines called Best Practices⁷ in 2000. The standards apply only to
members and do not have the force of law.
Federal Regulatory Response
By the late 1990s, consumer advocates were asking federal regulators, state
legislators, and Congress to address what they viewed as inadequate consumer protections
for the rapidly expanding operations of payday lenders. Some called for an outright ban
against payday loans while others argued for restrictions, increased disclosure, and
consumer education. Contractual arrangements between depository financial institutions
and payday lenders raised additional concerns for the federal regulators of banks and
thrifts.
On March 24, 2000, the Board of Governors of the Federal Reserve System
published a rule that added a section to the staff commentary on Regulation Z, the Truth
in Lending Act (TILA). The TILA requires creditors to disclose the cost of credit as a⁸
dollar amount and in terms of the APR. The commentary revision clarified that payday
loans are within the definition of credit in the TILA and, therefore, payday lenders are
required to provide the standard disclosures. Before the rule was issued some payday
lenders had stated that their cash advances to customers were not extensions of credit and,
therefore, should not be subject to the TILA.
Payday lenders drew the attention of the Office of the Comptroller of the Currency
(OCC), the Office of Thrift Supervision (OTS), and the Federal Deposit Insurance
Corporation (FDIC) when they sought arrangements with banks and thrifts to expand

⁵ Information on state laws was found on the National Conference of State Legislatures website,
[http://www.ncsl.org] .
⁶ In this report the term thrift refers to savings banks and savings and loan associations .
⁷ To view the Best Practices standards go to the CFSA website at [http://www.cfsa.net].
⁸ 12 C.F.R. Part 226.2(a)(14).

payday lending activities. These arrangements could be structured to include marketing,
servicing, and financing activities. The involvement of banks and thrifts might be sought
in an effort to avoid the state and local laws that would restrict the operations of payday
lenders. Certain federal preemptions of state law are granted by regulators to banks and
savings associations,⁹ so a partnership could facilitate the payday lender’s circumvention
of a state’s usury laws or other restrictions. The terms of individual agreements vary. In
an example situation, the payday lender would use a bank to initially fund loans
originated through the lender and then the bank would sell the loans back to the payday
lender. The payday lender would then service the loans and collect the payments.
Federal regulators responded to payday lender efforts by issuing advisory letters and
guidelines regarding contractual arrangements with nonbank, third-party vendors (payday
lenders) to fund payday loans. On November 27, 2000, the regulator for national banks
(the OCC) and the regulator for federal and state-chartered thrifts (the OTS) issued
advisory letters and supervisory guidelines relating to payday loans.¹⁰ The regulators
stated that payday loans were one example of a type of product being developed by non-
bank vendors that raised supervisory concerns because of the efforts by some vendors to
engage national banks and thrifts as delivery vehicles.
The joint statement by the regulators outlined several specific concerns. Consumer
protection concerns were raised because of loan terms and borrower characteristics. The
statement referred to non-bank vendors seeking to avoid individual state laws. The
regulators were concerned that the bank or thrift would not be significantly involved in
the marketing of the product. The institution might have an insignificant economic
interest in the business generated by the vendor and may not be able to properly oversee
the vendor’s operations. Concern was expressed that many vendors of these products
engaged in practices that may be viewed as abusive to consumers.
The regulators cautioned institutions about risks and safety and soundness threats.
Guidance issued by the OCC and the OTS highlighted the significant risks associated with
payday lending. Five categories of risk were analyzed; credit, counterparty (contractual),
transaction (operational), reputation, and compliance and legal risks.
The two regulators stated that individual institution management should carefully
weigh the possible ramifications of payday lending and should consult with their legal
counsel and regulators before pursuing payday lending. The regulators stated their intent
to scrutinize any such arrangements and to use their supervisory authority to examine the
operations of non-bank vendors.
The regulators also acknowledged that payday loans were responding to a consumer
demand for short-term, low-balance credit. They encouraged banks and thrifts to consider

⁹ For more information on federal preemption, see CRS Report RL32197, Preemption of State
Law for National Banks and Their Subsidiaries by the Office of the Comptroller of the Currency,
by M. Maureen Murphy.
¹⁰ The full text of the advisory letter and supervisory guidance can be found on the OCC website
at [http://www.occ.treas.gov/ftp/advisory/2000-10.txt] and the OTS website at
[http://www.ots.treas.gov/docs/7/77099.html ].

how this need could be served in a safe and sound manner, including the development of
alternative financial products.
On November 2, 2001, the OCC issued further guidance on the risks arising from
third-party relationships (including payday lenders) in an OCC bulletin.¹¹ The OCC
warned that third-party activity should be conducted in a safe and sound manner and in
compliance with applicable laws. The bulletin stated that the OCC would scrutinize any
arrangement. The Comptroller of the Currency has also made public statements directing
banks to avoid involvement with payday lending.
Enforcement actions have been taken by both the OCC and the OTS to halt payday
lender relationships with institutions they supervise. To date, the OTS has intervened
with two arrangements and the OCC with four. Consumer advocates state that a clear
signal has been sent by these two regulators to the institutions they supervise to stay away
from partnerships with payday lenders.
The FDIC is the primary supervisor for state-chartered banks that are not members
of the Federal Reserve System. On July 2, 2003, the FDIC responded to concerns raised
by banks becoming involved with payday lending by issuing examination guidance for
FDIC supervised institutions that participate in payday loans.¹² The guidance warned of
safety and soundness issues. The guidance discussed the high risk nature of payday
lending and referred to the five categories of risk addressed by the OCC and OTS. The
FDIC’s guidance may allow banks to participate in payday lending if strict requirements
and standards are met. The guidance instructs examiners to consider a comprehensive
range of regulatory factors when inspecting banks that do opt to be involved in these
arrangements. Factors include concentrations of credit, capital adequacy, loan loss
provisioning, and policies towards rollovers. The guidelines are to be applied during the
regular bank examination schedule.
In September 2004, consumer advocates testified¹³ that the FDIC guidelines are not
sufficiently stringent and that their enforcement may not provide needed consumer
protections. Ten state-chartered FDIC supervised banks were listed that had partnered
with payday lenders. Congress was urged to prohibit the use of checks drawn on banks
and thrifts as the basis for loans.
On March 1, 2005, the FDIC issued revised examination guidance on payday lending
programs. The FDIC expressed concerns about the manner in which payday lending was
being conducted. The revised guidance states that institutions should ensure that payday
loans are not provided to customers who have had payday loans outstanding from any

¹¹ The full text of OCC Bulletin 2001-47 can be found on the OCC website
[http://www.occ.treas.gov/ftp/bulletin/2001-47.doc].
¹² The full text of the guidance can be found on the FDIC website at
[ h t t p : / / www.f d i c .gov/ n ews/ news/ p r e ss/ 2003/ pr 7003.ht ml ] .
¹³ Testimony of Jean Ann Fox, in U.S. Congress, House, Committee on Financial Institutions
Subcommittee on Financial Institutions and Consumer Credit, Financial Services Issues: A
Consumer’s Perspective, Sept. 15, 2004.

lender for a total of three months in the previous 12-month period.¹⁴ Customers turned
down for payday loans should be provided with information on alternative credit products.
In addition, FDIC-supervised banks active in payday lending were instructed to submit
their plans addressing the revised guidance.
On March 11, 2005, the FDIC issued a cease and desist order against a state-
chartered bank that affiliates with payday lenders. The regulator ordered the bank to make
several improvements related to its payday lending activities.
Legislation
The operation of the payday loan industry and the criticism of this financial product^th
has raised congressional concerns. In the 109 Congress, five bills (S. 1878, H.R. 1643,
H.R. 1660, H.R. 4866, and H.R. 5350) addressing payday lending have been introduced.
S. 1878 and H.R. 5305 are similar bills with provisions that seek to prohibit or severely
restrict payday lending. The bills would amend the Federal Deposit Insurance Act to
prohibit an insured depository financial institution from making any payday loan (directly
or indirectly) or extending credit to another lender to advance payday loans. In addition,
the legislation would prohibit a creditor from making a payday loan based on holding a
personal check drawn on an account at an insured depository financial institution. H.R.
1660 would restrict the operations of payday lenders, regulate the involvement of banks
and thrifts, and set minimum national standards for state payday loan laws. H.R. 1643
would amend a variety of banking laws to protect borrowers from loans that in their terms
and relation to a borrower’s ability to pay may be abusive. Section 6 of H.R. 1643 would
amend the TILA. The new provisions would limit rollovers or loan extensions and
provide consumers with additional disclosure concerning the hazards of payday lending.
Section 306 of H.R. 4866 would also amend the TILA to limit rollovers or loan
extensions. Hearings have not been held on any of the five bills.

¹⁴ The full text of Financial Institution Letter FIL-14-2005 can be found on the FDIC website
[ h t t p : / / www.f d i c .gov/ n ews/ news/ f i n anci al / 2005/ f i l 1405.pdf ] .