[Senate Hearing 113-456]
[From the U.S. Government Publishing Office]





                                                        S. Hrg. 113-456


         ARE ALTERNATIVE FINANCIAL PRODUCTS SERVING CONSUMERS?

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                            
             FINANCIAL INSTITUTIONS AND CONSUMER PROTECTION

                                 of the

                              COMMITTEE ON
                              
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED THIRTEENTH CONGRESS

                             SECOND SESSION

                                   ON

   EXAMINING THE SMALL-DOLLAR CREDIT MARKET TO BETTER UNDERSTAND THE 
SPECTRUM OFALTERNATIVE FINANCIAL PRODUCTS, CONSIDER POTENTIAL CONSUMER 
 LENDING CONCERNS, AND REVIEW THE CURRENT FEDERAL AND STATE REGULATORY 
                               LANDSCAPE

                               __________

                             MARCH 26, 2014

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


                 Available at: http: //www.fdsys.gov /
                 
 
                                   ______

                         U.S. GOVERNMENT PRINTING OFFICE 

91-136 PDF                     WASHINGTON : 2014 
-----------------------------------------------------------------------
  For sale by the Superintendent of Documents, U.S. Government Printing 
  Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; 
         DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, 
                          Washington, DC 20402-0001
                
                 


            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon                 MARK KIRK, Illinois
KAY HAGAN, North Carolina            JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia       TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts      DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota

                       Charles Yi, Staff Director

                Gregg Richard, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                       Taylor Reed, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

     Subcommittee on Financial Institutions and Consumer Protection

                     SHERROD BROWN, Ohio, Chairman

       PATRICK J. TOOMEY, Pennsylvania, Ranking Republican Member

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         DAVID VITTER, Louisiana
ROBERT MENENDEZ, New Jersey          MIKE JOHANNS, Nebraska
JON TESTER, Montana                  JERRY MORAN, Kansas
JEFF MERKLEY, Oregon                 DEAN HELLER, Nevada
KAY HAGAN, North Carolina            BOB CORKER, Tennessee
ELIZABETH WARREN, Massachusetts

               Graham Steele, Subcommittee Staff Director

       Tonnie Wybensinger, Republican Subcommittee Staff Director

                                  (ii)


                            C O N T E N T S

                              ----------                              

                       WEDNESDAY, MARCH 26, 2014

                                                                   Page

Opening statement of Chairman Brown..............................     1

Opening statements, comments, or prepared statements of:
    Senator Toomey...............................................     2

                               WITNESSES

G. Michael Flores, Chief Executive Officer, Bretton Woods, Inc...     4
    Prepared statement...........................................    27
    Responses to written questions of:
        Senator Brown............................................    82
        Senator Toomey...........................................    84
        Senator Moran............................................    87
Stephanie Klein, Director, NetCredit Consumer Lending, Enova
  International..................................................     6
    Prepared statement...........................................    28
Nick Bourke, Director, Safe Small-Dollar Loans Research Project, 
  The Pew Charitable Trusts......................................     7
    Prepared statement...........................................    29
    Responses to written questions of:
        Senator Brown............................................    89
        Senator Toomey...........................................    97
        Senator Vitter...........................................   104
David Rothstein, Director, Resource Development and Public 
  Affairs, Neighborhood Housing Services of Greater Cleveland....     9
    Prepared statement...........................................    43
Nathalie Martin, Frederick M. Hart Chair in Consumer and Clinical 
  Law, University of New Mexico School of Law....................    11
    Prepared statement...........................................    47
    Responses to written questions of:
        Senator Brown............................................   109
        Senator Toomey...........................................   120

              Additional Material Supplied for the Record

Letter from Thomas J. Curry, Comptroller of the Currency, 
  submitted by Chairman Brown....................................   123
Letter from John W. Ryan, President and CEO, Conference of State 
  Bank Supervisors...............................................   125
Statement submitted by The American Financial Services 
  Association....................................................   127
Email submitted by Senator Vitter................................   166

                                 (iii)

 
         ARE ALTERNATIVE FINANCIAL PRODUCTS SERVING CONSUMERS?

                              ----------                              


                       WEDNESDAY, MARCH 26, 2014

                                       U.S. Senate,
Subcommittee on Financial Institutions and Consumer 
                                        Protection,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 10:03 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Sherrod Brown, Chairman of the 
Subcommittee, presiding.

              OPENING STATEMENT OF CHAIRMAN BROWN

    Chairman Brown. The Subcommittee will come to order.
    Thank you all for joining us. I thank the witnesses for 
being here and arriving on time. Senator Toomey, thank you for 
your cooperation, and Senators Heller and Warren and Senator 
Vitter was here a moment earlier, I believe is returning.
    I want you to imagine that--we apparently are going to be 
called out to votes around 11, and there are four votes, so we 
will go as long as we can and likely dismiss, because there are 
four votes. If that means all of us, including Pat and I should 
keep our remarks within 5 minutes and ask all of you to do the 
same.
    Imagine you are 40 years old. Imagine you are living in Mr. 
Rothstein's home State of Ohio. You are working at a steel mill 
in a union job. You are earning $60,000 a year. The plant shuts 
down. It could not compete. It might have been Oil Country 
Tubular Steel. It could not compete with illegal dumped imports 
from China.
    You manage to find a retail job working full-time making 
$22,000 or $23,000 a year. Your income is a fraction of what it 
used to be. Your costs are about the same, and some things--
perhaps food, gas, health care--are going up. You may lose your 
home to foreclosure. You are just trying to make ends meet, 
hoping you can just buy enough time until your next paycheck, 
with the perhaps distant hope of a better-paying job.
    You applied for several credit cards. You were denied. You 
decide to take out a payday loan or loan against the title of 
your car, but the money from your loan runs out before the next 
pay period. Like 80 percent of consumers in the CFPB's recent 
study, you end up rolling over your loan. You end up, like the 
average borrower, rolling your loan over six or seven times, 
eventually paying $575 in fees that you cannot afford on a $400 
loan. People are forced to turn to loans too often with triple-
digit interest rates that trap them in a cycle of debt that 
leaves them worse off than when they began.
    The Office of the Comptroller of the Currency said in 2003, 
about a different subject but similar in some ways, quote, ``a 
fundamental characteristic of predatory lending is the 
aggressive marketing of credit to prospective borrowers who 
simply cannot afford the credit on the terms being offered.'' 
The OCC was talking about mortgages in 2003.
    The results of predatory lending devastated millions of 
American families, far too many certainly in the States 
represented here, especially, I think, especially Nevada and 
Massachusetts--or Nevada and Pennsylvania and Ohio. During the 
financial crisis, one mortgage lender said, ``If you have a 
pulse, we give you a loan. If you fog the mirror, we give you a 
loan.''
    I am concerned we are now seeing this definition of 
predatory lending at work in small-dollar loan markets. For 
years, payday loans and other short-term small-dollar credit 
products were marketed to consumers and policy makers as a one-
time stopgap to get people through a temporary emergency. Now, 
we are seeing these products are being used to cover basic 
living expenses that lenders rely on repeat lending for their 
profitability. Obviously, a renewal, a rollover loan, is more 
profitable than the initial loan, which may not be that 
profitable to the lender.
    The cycle of a debt is a result of workers' wages 
stagnating over the past decade, American families' inability 
to accumulate enough wealth through savings over a lifetime 
spent working. Senator Toomey and I did a hearing on that, the 
bottom half of the population not being able to even close to 
saving any significant money for retirement. And the cycle of 
debt is a result of weak consumer protection, leaving consumers 
vulnerable to financial predators.
    This is a large problem. Twelve million Americans use 
payday loans for years. Small-dollar lending is an $80 billion 
per year business. There are more payday lending stores in the 
United States today than there are Starbucks and McDonalds 
combined.
    This problem is not simple. In my view, we need to raise 
the minimum wage. We need to extend unemployment insurance. We 
need to expand the Earned Income Tax Credit. All three of those 
rewarding work, so that people work hard, they get something 
and have some kind of decent standard of living. It puts money 
in people's pockets. It grows the economy.
    We need to do more to encourage savings and wealth 
building. Senator Moran from Kansas and I have introduced 
legislation to promote prize-linked savings accounts to help 
consumers build assets. And we need a strong CFPB and robust 
consumer protections to ensure these products are affordable 
and sustainable. It means limits on cost requirements that 
consumers can repay their loan, products with longer repayment 
terms, and the ability to pay down principal. People who are 
working--and most of the people in these situations are--should 
have a little bit more to say for what they have--for the work 
they have done.
    Senator Toomey.

             STATEMENT OF SENATOR PATRICK J. TOOMEY

    Senator Toomey. Thank you, Mr. Chairman.
    You know, I find this discussion always is a very 
interesting one to me. I think there is a broad acknowledgement 
that we have a huge segment of Americans who are what is 
sometimes described as underbanked. They do not have access to 
ordinary forms of credit, ordinary meaning that which typically 
higher-income, wealthier Americans have access to. And there is 
a vibrant, competitive market that meets the needs that they 
have, providing short-term credit in a variety of forms, under 
a variety of circumstances.
    And yet we have got people in this town who want to shut 
off this access to credit in a number of ways, use regulators 
to shut down the lending industry, directly or indirectly, 
sometimes by forbidding banks from providing basic services to 
these lenders. We have got some people who think the Government 
should take over the business. Let us have the Government do 
it, because the Government is so good at everything else it 
does. We have got others who think that the Government should 
dictate prices. That is what the Government is here for, it is 
to set prices for goods and services, and in this case, it 
would be the price of credit in the form of a cap on interest 
rates.
    There are lots of ideas that we hear, and the one idea that 
very seldom gets discussed is what about personal freedom? What 
about allowing free men and women to decide what works for 
them? I have got to say, there is a breathtaking underlying 
arrogance in the presumption by wealthy people who have never 
been in these circumstances that they know better than those 
people who make these foolish decisions and borrow this money 
from these institutions, an arrogance that suggests that, God 
forbid, we let people decide what is the most sensible thing 
for them to do in the circumstances that they face.
    And that is the fundamental premise here, that people must 
not be free to decide what credit vehicle is most suitable for 
them among the options that are available to them. We cannot 
let people decide for themselves. We must preclude a whole 
range of choices and force them into transactions that we 
sitting up here approve of.
    I just find that very, very disturbing. I know that view is 
not shared by everyone on this Committee. But, I appreciate the 
opportunity to have the discussion because I think we ought to 
hear from a wide range of opinions about this, and as for 
myself, Mr. Chairman, I hope that we will allow for a flexible 
and vibrant and dynamic marketplace that will allow people to 
access credit that they need in a variety of ways.
    Thank you.
    Chairman Brown. Thank you, Senator Toomey.
    Senator Warren.
    Senator Warren. I would like us to just get straight to the 
questions, so I will pass. Thank you.
    Chairman Brown. Senator Heller, would you like an opening 
statement?
    Senator Heller. No, Mr. Chairman.
    Chairman Brown. OK. Thank you for that. Let me introduce 
the panel and get started. I appreciate Senator Heller and 
Senator Warren's comments, or lack of comments.
    [Laughter.]
    Chairman Brown. Michael Flores is President and CEO of 
Bretton Woods, Inc. He has over 30 years of experience in the 
financial industry. He has testified to this Subcommittee 
before.
    Stephanie Klein of Enova is the Director of Consumer 
Lending for them, an online financial services company 
headquartered in Chicago. She oversees NetCredit line of 
Enova's installment loan products. Welcome.
    Nick Bourke is with Pew Charitable Trusts. He is the 
Director of the Pew Charitable Trusts Safe Small-Dollar Loans 
Research Project, conducting research on consumer needs and 
perceptions, market practices, and potential regulations of 
payday and other small-dollar loan providers. Welcome, Mr. 
Bourke.
    David Rothstein is familiar to this Subcommittee, also. He 
is the Director of Research Development and Public Affairs for 
the Neighborhood Housing Services of Greater Cleveland. He has 
published dozens of research reports, editorials, pieces of 
testimony on asset, housing, and consumer issues and has added 
greatly to the public debate on these issues.
    Professor Nathalie Martin is the Frederick Hart Chair in 
Consumer and Clinical Law at the University of New Mexico 
School of Law. Her primary research focus is on small-dollar 
lending and public attitudes toward these products. Professor 
Martin, welcome.
    Mr. Flores, if you would begin. Thank you.

   STATEMENT OF G. MICHAEL FLORES, CHIEF EXECUTIVE OFFICER, 
                      BRETTON WOODS, INC.

    Mr. Flores. Thank you, Chairman Brown, Ranking Member 
Toomey, and Members of the Subcommittee. I am grateful for the 
opportunity to speak with you today on the issues of consumer 
credit and also discuss the results of a report I recently 
completed on the customer and loan characteristics of online 
short-term loans.
    I worked in banking consulting for well over 30 years, and 
in the past 15 years, I have conducted research on short-term 
credit, including overdrafts and payday loans, and in the last 
6 or 7 years, I have studied prepaid cards, as well. I am also 
on the faculty of the Pacific Coast Banking School of the 
University of Washington, where I teach a retail banking 
course.
    Based on my most recent research, which was commissioned by 
the Online Lenders Alliance, and analysis of other studies, the 
need for short-term low-dollar products is real and the demand 
is growing. I just noticed an article in the Washington Post. A 
Brookings Institution study says that now one-third of all 
households are living paycheck to paycheck, so the income is 
creeping up higher into the middle class for the need for 
short-term credit.
    The Center for Financial Services Innovation estimates the 
annual demand for unsecured short-term credit to be about $61 
billion, of which $8.5 billion was of overdrafts, $4.5 billion 
of deposit advance products, which probably now will tend 
toward overdrafts, Internet payday loans of $18.5 billion, and 
storefront payday loans of $30 billion. The intent of this 
study was to build a first of its kind analysis. This is the 
largest data analysis commissioned by the industry to look at 
what data was available, both from the specialty credit bureaus 
as well as the lenders. We also wanted to comment on the 
strengths and weaknesses of the data that was out there, 
establish a baseline from which future annual updates can be 
based, to try to provide an initial understanding of customer 
demographics and loan usage patterns, and, of course, compare 
this data to other research, such as Pew and CFPB in order to 
add information to this discussion.
    We analyzed over 60 million application records from the 
three specialty credit bureaus. That included nine million loan 
records over a 4-year period beginning in 2009. Because of 
certain constraints, and I will be happy to talk about that 
later, within the credit bureau data, we added an additional 
1.6 million customer records from three lenders around the 
country.
    The key findings, for the most part, track closely with Pew 
and CFPB. Of course, there are a few exceptions. In general, 
the median age of the customer is 39, annual median income of 
$30,000, and they are generally paid on a bi-weekly basis. The 
average loan amount is about $400, but, I think, most 
interestingly, is that average loan amount has increased from 
2009, about $380, to over $530 in 2013.
    The average annual number of loans range from two to four, 
with 30 percent of customers having only one loan. This is 
where we differ a little bit from the other studies, and part 
of it is due to methodology and part of it is due to the data 
that was available.
    Annual days indebted range from 70 to 106 days, which 
compares to Pew's analysis of 144 days and CFPB's analysis of 
the storefront loans of 199 days.
    Finally, loan performance from the credit bureaus indicate 
71 percent of the loans were paid as needed, and 89 percent had 
no charge-off flags.
    I believe the growth in loan amount as well as the 
intensity of usage characteristics has led to a trend of the 
industry moving from the 2-week product to an installment 
product. The installment product, I believe, will provide more 
flexibility for the consumer and will lead to less cost for the 
consumer. That said, I still think there is a viable need for 
the 2-week product and that it fits within the continuum of 
credit services needs in that the 2-week product is going to be 
less expensive than an overdraft, and an overdraft is going to 
be less expensive than returning a check insufficient.
    Innovative companies, many of them operating exclusively on 
the Internet, are trying to develop innovative products to 
drive down cost. In my discussions with these companies, they 
say the real innovation is limited because of the patchwork of 
State laws that are out there. I believe Federal law is needed 
to establish consistent rules and regulations to allow these 
companies to innovate and drive down costs.
    I notice an interesting quote from the Office of the 
Comptroller of the Currency in 2011. I will paraphrase, but it 
is that in the 21st century, the Internet and the advent of 
technological innovations has accentuated the seamless--the 
geographic seamlessness of financial services products. So, we 
have let the genie out of the bottle. People can go on the 
Internet, see what products are available, but they are 
constrained by State regulations in terms of what products they 
can get.
    I believe H.R. 1566 is probably the best vehicle currently 
available and enjoys close to 50-50 bipartisan cosponsorship to 
allow customers access to credit on a national basis.
    Thank you for your time, and I look forward to answering 
your questions.
    Chairman Brown. Thank you very much, Mr. Flores. Thank you 
for staying within the 5 minutes, too. I appreciate that.
    Ms. Klein.

  STATEMENT OF STEPHANIE KLEIN, DIRECTOR, NETCREDIT CONSUMER 
                  LENDING, ENOVA INTERNATIONAL

    Ms. Klein. Good morning, Members. Thank you, Chairman 
Brown, for inviting me here today. Again, I am Stephanie Klein. 
I am a Director of Consumer Lending at Enova. We are a global 
leader in online financial services, headquartered in Chicago. 
I am really grateful for the opportunity to share some of our 
experience with you today.
    Senators, I am here to tell you about the exciting new 
credit solutions we have been developing, what we have learned, 
who we are serving, and how we can help underserved consumers 
have equal access to quality credit. We believe we can change 
the dynamics in the industry and provide a pathway toward 
upward mobility that will benefit millions of hardworking 
Americans who have been left behind by the traditional banks.
    At Enova, since our launch in 2004, we have been using 
advanced technology and analytics to create innovative products 
that meet consumers' evolving credit needs. I oversee 
NetCredit. NetCredit is one of Enova's newest installment 
lending products for U.S. consumers. With NetCredit, customers 
can borrow $1 to $10,000 and pay back over time in fully 
amortizing installments over 6 to 48 months. Payment amounts 
are typically just 6 to 8 percent of gross paycheck, and we 
actually derived this ratio through rigorous testing of 
customer behavior.
    But just recently, we also released a new tool where 
customers can actually vary their payment amount online, and in 
real time, they can see the impact on the duration of the loan 
as well as the total cost of borrowing as they customize their 
payment. And interestingly, since we released this new tool, we 
have seen that customers, on average, are self-selecting that 
same 6 to 8 percentage of gross paycheck that we had calculated 
and targeted historically. So, I think this is a true testament 
to the power of the advanced analytics capabilities that we 
have developed over the past decade at Enova.
    Our customer demographic does present a unique challenge 
when it comes to pricing. While NetCredit customers typically 
have moderate incomes, usually ranging from about $40,000 to 
$60,000, and they always also have an active bank account, they 
have very low credit scores. Compared to the average U.S. FICO 
score of 689, 90 percent of NetCredit customers score below 
650, and the vast majority are actually below 600. So, we are 
really serving a very high-risk borrower who traditional banks 
are not willing or able to serve.
    Our answer to this challenge is a unique risk-based pricing 
algorithm. By leveraging multiple data sources and evaluating 
literally hundreds of variables, we have been able to 
successfully distinguish high-risk borrowers from lower-risk 
borrowers and price accordingly. As a result of this 
innovation, NetCredit's average interest rates are 50 percent 
lower than other leading online lenders, and almost 75 percent 
lower than a typical payday loan product.
    Furthermore, because we use the simple daily interest 
method, customers can save money by making early payments when 
they have extra funds. There are no fees to our loans, simple 
interest only, no origination, application fees, nothing up 
front. So, I think this is a benefit, and, in fact, one-third 
of our customers take advantage of this benefit and do choose 
to pay back their loans early.
    Over the past 2 years, we have been working hard to foster 
relationships with the major credit bureaus. We have dedicated 
significant resources to this effort and we are very excited to 
help customers start building credit with these products. This 
is a unique benefit that cannot be offered with 2-week 
products, but is possible with longer-term installment loans.
    Now that I have told you a little bit about what we are 
innovating and some of the benefits we can offer our customers, 
let me tell you about the significant challenges we face due to 
the current regulatory landscape.
    It is our belief that current State laws do not adequately 
serve consumers. Instead of working toward innovative solutions 
that can be scaled across 50 States, we are forced to develop 
new products for individual States within the constraints of 
antiquated consumer credit statutes that were never drafted 
with current technologies or Internet lending in mind. In many 
cases, instead of allowing customers a choice of quality credit 
products, the State law actually forces customers into the 
single-payment loan as their only option.
    Our mission at Enova is to create high-quality innovative 
products that can not only serve an immediate credit need, but 
can also help customers achieve a better financial future. We 
have proactively shared our experience with groups like the 
Center for Financial Services Innovation and the CFPB's Project 
Catalyst in order to promote discussion on how we can design 
policies that help working families throughout the country 
achieve equal access to credit. We envision uniform Federal 
standards that enable innovation to meet the needs of today's 
increasingly mobile, tech-savvy consumers. I encourage all of 
you to support legislation to modernize our laws for the 
benefit of the 68 million Americans in this country who do not 
currently have sufficient access to credit.
    Thank you, Chairman Brown, thank you, Committee Members, 
for allowing me to be here and share this testimony and I look 
forward to any questions.
    Chairman Brown. Thank you, Ms. Klein.
    Mr. Bourke.

  STATEMENT OF NICK BOURKE, DIRECTOR, SAFE SMALL-DOLLAR LOANS 
          RESEARCH PROJECT, THE PEW CHARITABLE TRUSTS

    Mr. Bourke. Thank you, Chairman Brown and Ranking Member 
Toomey, Members of the Committee. My name is Nick Bourke. I am 
with the Pew Charitable Trusts. We are a large 501(c)(3) 
nonprofit organization. A big part of our mission is to 
generate good quality research that helps inform good public 
policy, and I would like to focus today on the research that we 
have been conducting over the past 3\1/2\ years about payday 
and small-dollar lending.
    Payday lending, as, Chairman Brown, you outlined very well, 
this is typically a 2-week balloon payment loan that is due 
back in full on the borrower's next payday. Payday lending is 
an experiment that began in the early 1990s in this country, 
and the goal was to try to make more credit available to 
financially fragile consumers. Unfortunately, this experiment 
has not worked out too well.
    When people get a payday loan, the only real requirements 
are that they have a checking account and that they have an 
income stream. If they have those, and the lender then uses 
their unique power to leverage the checking account and gain 
access to the borrower's checking account and income stream, 
that acts--that stands in for the underwriting.
    About 12 million people use these loans each year. Why do 
they use them? Well, in Pew's nationally representative survey 
of payday loan borrowers, where we called people throughout the 
country and screened through about 50,000 people in order to 
get enough payday loan borrowers to give in-depth interviews to 
represent all borrowers across the country. We asked, what is 
your financial situation, and what payday loan borrowers said, 
58 percent of them, was they have trouble paying their monthly 
bills half the time or more. And one-quarter of payday loan 
borrowers said they have trouble paying their monthly bills 
every single month.
    Most have debt already. More than half of payday loan 
borrowers have credit card debt. Forty-one percent own homes, 
so there are mortgages. Many of them have student loans. Many 
of them have auto loans. People are carrying debt. Almost all 
payday loan borrowers have a credit score, and the average 
score is 517. This indicates that people are already struggling 
with debt. They are at the bottom of the barrel in terms of 
credit score.
    They are failing out of the mainstream credit system. They 
are not trying to get into it. They have been there and they 
are failing out. This is really important to remember when we 
think about what is the right solution here and how can credit 
help them or how can it not help them.
    When we ask people, why did you get your payday loan, what 
did you use the money for, 69 percent of borrowers said that 
the reason they got their payday loan, unsurprisingly, perhaps, 
was to help them pay their bills--rent, utilities, credit card 
bills. Only 16 percent said that they turned to a payday loan 
for some kind of unexpected expense, like a car breaking down 
or a medical emergency.
    So, this paints a vivid picture of financial struggle and 
why people are turning to the loans. It also helps us 
understand why this product, why this market is not serving 
this consumer.
    A payday loan typically requires a balloon payment of $430, 
on average, out of the borrower's next paycheck. The typical 
borrower is making about $30,000 a year. That is about $1,200 
every 2 weeks. The payday loan is requiring them to sacrifice 
one-third of their next paycheck toward a payday loan. That is 
unaffordable and it is not working.
    The message that I want to convey is there is a solution. 
There is a way out of this. The status quo is not working. Pew 
has recommended five policy recommendations to help address 
this problem.
    The first one relates to an ability to repay principle. The 
payday loans are not working because they are fundamentally 
unaffordable. The way to address this is to require lenders to 
consider the borrower's ability to repay. If one-third of the 
paycheck is too much to pay, what is the right benchmark? Our 
benchmark, based on research, is 5 percent. Loans should not 
take more than 5 percent of a person's paycheck unless the 
lender is doing some really serious underwriting to make sure 
that the borrower can afford it.
    Number two, spread costs evenly over the life of the loan. 
Simply turning the loans into installment loans is not going to 
work. We need to have some simple safeguards to make sure that 
the problems that we see in installment loan markets, with 
frontloading of fees and interest, large origination fees, 
giving incentive to refinance or flip loans, we need to protect 
against those.
    Number three, guard against harmful repayment or 
collections practices. Generally, we need to make sure that 
borrowers have a little bit more power, a little bit more 
security to stop electronic payments in the face of 
unscrupulous lenders or overly aggressive debt collectors.
    Number four, concise disclosure so people can get good 
information to make good decisions.
    And number five, States should continue to set maximum 
allowable interest rates because data suggests that the small-
dollar loan markets serving people with damaged credit are not 
price competitive.
    Pew has done a case study in Colorado where they 
essentially implemented reforms along these lines in 2010, and 
what we saw there is that it worked. Access to credit has been 
maintained and borrowers are spending much less and being much 
more successful with reasonably structured loans with sensible 
safeguards.
    Thank you very much.
    Chairman Brown. Thank you, Mr. Bourke.
    Mr. Rothstein, welcome.

 STATEMENT OF DAVID ROTHSTEIN, DIRECTOR, RESOURCE DEVELOPMENT 
 AND PUBLIC AFFAIRS, NEIGHBORHOOD HOUSING SERVICES OF GREATER 
                           CLEVELAND

    Mr. Rothstein. Thank you. Senator Brown and Ranking Member 
Toomey, I appreciate the opportunity to testify before you 
today. Outlined in this testimony, I hope to convey the 
importance of strong regulation around small-dollar lending, 
particularly from the Federal Government, as local authorities, 
such as my State of Ohio, continue to wrestle to ensure that 
consumers receive safe and affordable loan products.
    It is imperative, as Nick discussed, that we look at the 
characteristics of the loan, such as APR interest and method of 
payback, to assess the quality of the products. First, the 
traditional payday loan model in Ohio is alive and, as in other 
States, does not serve families well. Research of actual 
borrowers continues to tell that story in numerous ways, even 
in the report that was just released by the CFPB yesterday.
    I say that it does not serve them well because the average 
family takes out eight to 12 loans per year from one lender, 
typically purchasing loans in back-to-back transactions. This 
is absolutely the typical Ohio customer. This means as soon as 
their loan is repaid, they immediately reborrow to cover other 
expenses. This is also the prototypical discussion of what we 
call the debt cycle.
    Our housing and financial capabilities counselors in my 
office indicate that most clients that have one loan have about 
four other loans from other stores. Keep in mind that many 
families cannot afford to pay back the principal balance of the 
loan in just 2 weeks, let alone interest and principal. And if 
payback does occur, other monthly budget items, such as rent, 
utilities, food, and car payments, suffer. In sum, we see the 
people after they have exercised their freedom to take out 
these loans and they want out.
    Second, payday lenders in Ohio have morphed into auto title 
and installment lenders. This is quite typical and quite often 
more expensive. In 2008, the General Assembly in Ohio passed a 
bipartisan bill to curtail interest rates. The new APR was 28 
percent interest. This is a significant reduction, since 
lenders before had been charging 391 percent interest. Despite 
spending at least $10 million in a ballot referendum to reverse 
the decision, not a single payday lender in Ohio uses the 
short-term loan act that was passed. Rather, they use two 
antiquated mortgage lending laws to sell loans at essentially 
the same price, if not more, than before.
    Most recently, as I indicated, in Ohio, stores are selling 
high-cost loans that use automobile titles as collateral rather 
than a postdated check. An auto title loan is often more 
dangerous than a payday loan in the sense that people can, and 
do, lose their cars once they are too far into debt. I have 
included in my testimony a three-part story from the Akron 
Beacon Journal about a working mother of three who lost her car 
and nearly her home after this loan. With the help of several 
nonprofits and the writer for the article, she was actually 
able to get her car back.
    Installment loans, the newest payday product in Ohio, are 
offered by payday lenders and they carry a similar triple-digit 
interest rate and use the Credit Service Organization statute 
to sell loans for up to 12 months. One loan that I analyzed 
from a store about 5 minutes from our office cost a borrower 
$5,000 to borrow $2,000 over a 12-month period.
    Finally, at NHS of Greater Cleveland, we practice what we 
preach. Since we advocate smart home ownership, we purchased 
our building in the recovering area of Slavic Village, Senator 
Brown's new neighborhood. Since we are notably critical of 
payday lending, we are developing two alternatives. Working 
with the innovative startup company Employee Loan Solutions, we 
will be working with large employers to provide safe, 
underwritten, low-cost loans through paychecks. The lender is a 
CDFI focused on providing low-income families with affordable 
financial products. There is underwriting. There is no 
prepayment penalties and certainly no balloon payments.
    The other program is a small-dollar loan serviced and 
managed by NHS of Greater Cleveland. The intent is to comply 
with Ohio's payday lending law of under 26 percent APR. We will 
be much lower than that. We will be the only group in Ohio to 
comply with Ohio's payday lending law.
    As this Congress and Consumer Financial Protection Bureau 
consider rules and regulations around small-dollar lending, a 
floor on small-dollar loans will encourage high-quality 
innovation. Nick mentioned their principles through Pew. I 
would also recommend CFSI's principles around small-dollar 
credit. They are also quite strong.
    Lenders should be required to fully assess a borrower's 
ability to repay a loan in full and on time without the need 
and use of cashing a check or electronic debiting an account. 
Just like mortgages or credit cards, ability to repay 
requirements protect borrowers from unsustainable debt. The 
litmus test for automatic payment should be that it is a 
convenience for the borrower, not a sidestep for debt 
collection laws.
    I really do appreciate your time today and I am looking 
forward to question and answer and I am happy to, again, answer 
any questions that you may have. Thank you for your time.
    Chairman Brown. Thank you, Mr. Rothstein.
    Professor Martin, welcome.

   STATEMENT OF NATHALIE MARTIN, FREDERICK M. HART CHAIR IN 
 CONSUMER AND CLINICAL LAW, UNIVERSITY OF NEW MEXICO SCHOOL OF 
                              LAW

    Ms. Martin. Thank you very much. Good morning, Chairman 
Brown, Ranking Member Toomey, and other Members of the 
Subcommittee.
    As Senator Brown indicated, my research focuses on high-
cost loans, and I have done several empirical studies, 
including one in which we interviewed real borrowers curbside. 
I also work directly with consumers in our clinical law 
program, and as a result have had a tremendous amount of 
contact with actual borrowers of these types of loans. So, this 
borrower contact, I believe, informs my testimony today in a 
way that book research simply cannot.
    As I understand the goals of the hearing today, they are to 
identify fair, affordable access to credit for all, but fair 
and affordable are not words that I would use to describe the 
loans that are the subject of this hearing.
    We have not talked too much yet about interest rates, but I 
would like to do that for just a moment. Storefront payday 
loans, I think, as Mr. Rothstein said, typically carry an 
average rate of about 400 percent per annum and title loans 
about 300 percent per annum, but, of course, there is the risk 
of losing your car with those.
    With the installment loans, though, that Mr. Rothstein 
mentioned, that are generally designed to get around State 
regulation, the rates can be much, much higher. For example, 
one consumer that I know borrowed $100 and paid back $1,000 
over a year's time. The rate on that loan is 1,100 percent 
interest. And the important thing is that that loan is legal in 
many States. That is a legal loan.
    The biggest challenge we have, though, in terms of 
regulating these forms of credit is in the area of online 
lending. This is a growing segment. It is growing by leaps and 
bounds. Those rates are higher than storefront payday loans--
800 to 1,000 percent is very typical--and there is very little 
regulation of these online lenders. The SAFE bill that was 
proposed by Senators Merkley, Udall, and others will be very 
helpful, but I think it is also very important for the CFPB to 
have as much power as possible to regulate that form of credit.
    And on the topic of the CFPB, it is actually--as far as I 
am concerned, nothing is more critical at this moment than 
protecting the CFPB's ability to regulate this entire high-cost 
loan industry all across the spectrum of small-dollar lending, 
not just focusing narrowly on payday lending, because of the 
loopholes that Mr. Rothstein talked about.
    You know, I also have been watching very closely and 
following every State law that has passed in order to curb 
these lending practices and watching in nearly every State as 
lenders find ways around the laws that pass. As new State laws 
pass, other than interest rate caps, interest rates and fees do 
not go down. Indeed, what happens is that they either stay the 
same, or usually, they go up after the new law. And, no matter 
how many lenders enter this market, no matter how many, the 
rate does not go down. So, what we can see is that the market 
is not working in this particular context.
    And we heard from Ms. Klein about an Internet lending 
company that may offer a new product that could be 75 percent 
cheaper than existing online loans, or 50 percent cheaper than 
storefront loans. Keep in mind, those would still be 200 to 300 
percent loans. So, even if that is OK, my real bone to pick is 
with the idea that somehow this Federal charter is going to 
make the rates go down. That is not the history. If history is 
any indication, additional freedom imparted on the industry 
under this charter will only cause the rates to go up, or, at 
best, to stay the same. In any event, any bill that is proposed 
by industry, if looking at that, consider the compliance record 
of the existing industry. Is this the place we want to look for 
our solutions?
    So, what are the solutions and the alternatives? We have 
heard about some of them. One would be, of course, true 
underwriting of the loans, meaning the lender has to determine 
that the borrower actually has enough money to pay their 
regular bills plus the loan or the loan is not enforceable.
    Another very important thing, based upon the recent CFPB 
paper that came out yesterday, would be to prohibit rollovers 
and limit the numbers of loans through a national data base, 
and that means if the lender did not use the national data 
base, then the loan would not be enforceable.
    I think both of those are viable options. If lenders feel 
that this is too complex, there is always a much simpler 
solution, which would be a Federal interest rate cap. And, by 
the way, although I know not many politicians favor that, the 
general public very much does favor interest rate caps, and I 
have attached a paper to my testimony so indicating.
    I guess the last thing I would say is I am very excited 
about other options that are being developed in the 
marketplace, the CDFIs that Mr. Rothstein spoke about as well 
as the idea of having the U.S. Postal Service get into this 
business.
    Thank you very much for your time.
    Chairman Brown. Thank you, Professor Martin, and all of 
you, thank you for your trenchant testimony.
    You may have heard from Senator Toomey's and my opening 
statements that we have a sort of different view of this and 
the role of Government, but I see some seeds of hope in Mr. 
Bourke's testimony and Mr. Rothstein's attempts in Ohio, and I 
hope there is a way we can get to some of these solutions for 
the unbanked that Senator Toomey spoke about.
    Let me specifically--I want to ask this directly to all of 
you, starting with Professor Martin--the Pew studies--I think 
there were three you did with some 50,000 calls to consumers, 
so a pretty good cross-section of people--show that consumers 
use payday loans even when they have cheaper credit liquidity 
available to them. Forty-one percent eventually paid off their 
loans using one of these options--credit cards, bank loans, 
pawn shops, other short-term loans. Borrowers have chosen to 
use payday loans when there is liquidity in their checking 
account in many cases.
    Mr. Rothstein describes two products that Neighborhood 
Housing Services is developing. There have been reports about 
other affordable small-dollar products. You mentioned some of 
the examples in Colorado. Key Bank in Cleveland, a regional 
good-sized bank--midsized bank in Cleveland--has offered a $250 
to $1,500 line of credit with a 14 to 19 percent interest rate, 
up to 5 years for repayment, two fees totaling $25. They say 
this product can be profitable.
    So, my question, starting with Ms. Martin and moving from 
my right to my left, is why do borrowers use the high-cost 
payday loans when there are, in many cases, alternative 
affordable--alternatives available to them that are affordable? 
What do these choices tell us about borrowers' behavior?
    Ms. Martin. So, I think, initially, there is a confusion on 
the part of borrowers about the rates. So, if they hear, oh, 
the rate is $15 per $100, they think that is a 15 percent per 
annum rate, even though it is only for 2 weeks. It is a 400 
percent loan. And in my study, I found that there were people 
who thought that was actually going to be cheaper than using a 
25 percent credit card, for example. So, that is part of it. 
Enumerancy, in general. You know, people cannot do math. That 
is a problem that we have seen in society.
    And I think people also look at these--if there is a lender 
on every corner, they are thinking that is kind of a normal 
thing to do, and I have even heard people say, ``Oh, no, I 
would not use a credit card for that. Those are only for 
emergencies.'' So, I think the advertising, the ubiquity of the 
industry makes people think this is a better option somehow.
    Chairman Brown. Mr. Rothstein.
    Mr. Rothstein. I think Nathalie is right on. I think there 
are two things, also, that our financial counselors have 
noticed. One is a sense of optimism in that people are 
generally feeling that in 2 weeks, they will be in a better 
position than they are before, and a lot of this has to do with 
just the nature of work and temp work and those kind of things, 
and often, they are not.
    And then the second thing is, I would argue, and I think 
the Pew studies, the CRL studies have really shown, that after 
the first or second loan is taken out, the choice to take out 
other loans becomes dramatically reduced because they are going 
to be short for their other expenses after they pay back the 
loan or after the lender runs the check through that they have 
postdated. So, I think the argument of after the first or 
second loan how much of a choice it is is debatable.
    Chairman Brown. Mr. Bourke.
    Mr. Bourke. In our second report, we identified six reasons 
why people use unaffordable payday loans, and one of them is 
desperation. Thirty-seven percent of borrowers in our survey 
said that they have been in such tight financial circumstances 
that they would take any loan on any terms.
    Other reasons relate to perception and reliance. A 
consistent theme that we have heard in focus groups with 
borrowers is that, hey, I already have enough debt. I already 
have enough bills. I do not need another bill. I do not want 
more debt. I have gotten in trouble with credit cards before. I 
am just going to get this payday loan because it looks like I 
can get in and get out quickly and I am not going to add 
another bill to the pile. The reality, of course, is very 
different.
    There are several other reasons, but one thing I want to 
point out, a good way to think about this and analyze it, I 
think, is to compare what the product looks like or how it is 
packaged to the reality of the situation. And in the 
conventional payday loan market, the product is typically 
packaged as a short-term product for unexpected expenses. In 
fact, the industry will typically say, do not use these loans 
for long-term use or anything more than a temporary need.
    But the business model of payday lending is built on 
extended usage and a lot of data shows this very clearly, 
including the payday loan study that came out yesterday from 
the CFPB. The vast majority of volume in the payday lending 
market, the vast majority of revenue comes from people who use 
the loans repeatedly over an extended period of time. And if 
most borrowers--or, I should say, if borrowers used the loans 
as packaged, the business model of payday lending would fall 
apart. It is absolutely reliant for its profitability on 
extended usage.
    Chairman Brown. Thank you.
    Ms. Klein, is he right that your products from Enova and 
other companies are packaged for short-term one-time loans, but 
the model is something--your business model is something 
different?
    Ms. Klein. So, just to be clear, I do not run a payday loan 
business. I mean, my product is an installment loan. I cannot 
speak for others in the industry. What I can say for Enova is 
that we proactively in every State where we can have been 
moving toward longer-term loans. What I really like about the 
installment loan is under its Federal regulation, there are 
clear and transparent disclosures up front. So, when a customer 
borrows from us, they see the principal amount, they see the 
APR, they see the total finance charge in dollars, which may 
make more sense to a lot of customers than an APR calculation, 
and they see the payment amount.
    So, really, in my opinion, you know, why do customers use 
these products? Because there is a need that is being unmet. If 
these other solutions people talk about were meeting the need, 
the products would not exist. So, there is absolutely a need 
and what we need to focus on is how do we bring higher-quality 
products to market at scale so that the millions of Americans 
who need them have access.
    Chairman Brown. Mr. Flores, you have had the Online Lenders 
Alliance. You have done studies for them. Is Mr. Bourke right 
about that, that the packaging for short-term one-time loans is 
different from the actual business model?
    Mr. Flores. Well, Senator, what I have tried to do with our 
studies is build data for the analysis of their product and how 
customers use their product. I have not done specific work for 
vendors or lenders within that industry. So, I cannot really 
comment on the business model versus the product.
    Chairman Brown. OK. Senator Toomey.
    Senator Toomey. Thanks, Mr. Chairman.
    Ms. Klein, we have heard just now the characterization of 
the lending that goes on in this industry, the ideas that there 
is indiscriminate lending. Basically, if you have got a bank 
account and a job, you get a loan. There are balloon payments. 
People do not consider--lenders do not consider a customer's 
ability to repay. Did it ever occur to you to consider a 
customer's ability to repay, or are you indifferent to getting 
your money back?
    Ms. Klein. Thank you for asking that question. That is a 
great question. You know, obviously, if our customers cannot 
pay, we do not make money. So, if our customers are not 
successful, we are not successful.
    Just to give you a little insight--again, I cannot speak 
for everyone in the industry, but as to how NetCredit evaluates 
that--we are spending a lot of money, typically $30 to $50 per 
funded customer, on underwriting. We are pulling prime data, a 
Vantage score, you know, similar score from a prime bureau. And 
we are also pulling alternative data from about five different 
data sources. So, we use all of this data up front to try to 
come up with a loan offer that would be appropriate.
    Additionally, after a consumer expresses interest in that 
product, we are doing some sort of verification for everybody. 
Nobody gets an auto approval on the NetCredit loan. So, we are 
checking employment. For a lot of people, we are looking at 
bank statements. Because we are online, we are verifying 
identity. We do a ton of verification, and as a result of that, 
our approval rates are typically only 15 to 20 percent. So, 
this is not walk in, fog up a mirror. I do not know how you 
would do that in the online metaphor, but----
    Senator Toomey. So you----
    Ms. Klein. ----but that is not how we do our business.
    Senator Toomey. To be clear, so, you are rejecting 
applications from 80 to 85 percent of the applicants because 
they do not meet your credit standards?
    Ms. Klein. Correct.
    Senator Toomey. Is that----
    Ms. Klein. We reject 80 to 85 percent, and additionally, 
just to kind of speak on, well, these customers are desperate, 
not every customer that we approve chooses our product. And we 
see, especially online, it is much easier to comparison shop--
--
    Senator Toomey. So, there is competition.
    Ms. Klein. and so once you make an offer, at least 40 
percent of people typically walk away, and that is fine, and 
they are looking for the right choice for them.
    Senator Toomey. So, you are not able to set any old rate 
you like, because if you do, someone else who competes with you 
will set, presumably, a lower rate and competition imposes a 
discipline in this space. Is that a fair----
    Ms. Klein. That is absolutely correct, and I would say, 
really, it has been recent, but in the past year, especially in 
the online space for installment lending, we have seen prices 
come down. I would like to think that NetCredit was one of the 
first lenders to start driving that effort, but we have 
actually seen other lenders innovating in the same way. And so 
I think competition can work online.
    Senator Toomey. It seems obvious to me, but just maybe you 
could confirm. The kind of underwriting you do would not have 
been possible, certainly, 10 years ago, probably not even 5 
years ago, but advances in technology and access to data and 
evolving techniques have made this kind of underwriting 
possible recently.
    Ms. Klein. That is absolutely true. I mean, I will not 
waste too much of your time, but I could list off a ton of 
tools, data vendors that are available today that were never 
available historically, and we are constantly testing with new 
vendors. There is not a day that goes by where, in addition to 
the data we already use, we do not have a few other vendors 
where we are doing a retro study, we are saying, hey, here is 
some data, give us your data. How can we do better? How can we 
get smarter about underwriting? It is an ongoing effort.
    Senator Toomey. Thank you.
    Mr. Flores, I wanted to ask you a question and ask you to 
describe a little bit to us a program which, I think, has a 
name, called Operation Choke Point, if I have that right. My 
understanding of this is a systematic effort on the part of 
some bank regulators to pressure banks into not providing 
ordinary services to the short-term lending industry as a way 
to indirectly shut down this industry. Despite the fact that 
the industry is operating in a perfectly legal fashion and they 
might be very good and, in fact, profitable customers for the 
bank, it seems that some regulators believe that without any 
Congressional authority, they ought to be able to shut down an 
industry because they do not like it. Do I have that roughly 
correct, and could you----
    Mr. Flores. Yes, sir----
    Senator Toomey. ----describe what is happening here?
    Mr. Flores. ----that is correct. I believe what they have 
done is take what would be a shotgun approach. I mean, many of 
the lenders who are licensed in the States to operate are 
operating in a legal business environment and I do not see the 
cause to restrict them from access to the payment systems to 
conduct their business. Now, yes, there are unlicensed offshore 
vendors and I think that a more targeted approach to address 
the unlicensed operators would be much more appropriate in 
dealing with the bad actors than just shutting down an entire 
industry.
    Senator Toomey. And, finally, if we had a new regulatory 
regime that forbids categories of transactions and puts 
Government dictated pricing limits on these transactions, is 
there any chance that some people who currently need and get 
access to credit will no longer have that access to credit?
    Mr. Flores. Absolutely. It is the nature of price controls. 
The 36 percent annual APR has been talked about a lot. In 
small-dollar lending, particularly to a high-risk customer 
group, given the cost of originating, servicing these types of 
credits, you cannot properly make those loans. Banks have 
gotten out of the business of small-dollar unsecured consumer 
credit, probably 15, 20 years ago when they migrated to credit 
cards and then overdrafts and then home equity lines of credit. 
So, it is a real problem.
    The deposit advance program is an example. That is close to 
$5 billion of credit. And I talked to some people that were in 
the industry in those banks that say it is probably actually 
closer to $10 billion, but you see FSI's number of $4.3 billion 
of credit extended. That has gone away. The demand has not been 
ameliorated.
    Where does that go? Well, if these customers are customers 
of those banks that offered the product, the next likelihood 
for them to do is then the overdraft, which is going to be a 
much more expensive option than that deposit advance product. 
So, you limit supply of certain products, you are going to 
force customers--unless you somehow deal with the demand, you 
are going to force customers into products that are not 
suitable for them.
    Senator Toomey. Thanks very much. Thank you, Mr. Chairman.
    Chairman Brown. Thank you, Senator Toomey.
    Senator Warren.
    Senator Warren. Thank you, Mr. Chairman. Thank you for 
holding this hearing.
    So, there are 34 million families in the U.S. that are 
unbanked or underbanked, meaning they rely on check cashing, on 
payday lending or other financial services outside the 
traditional banking system. The cost for these families is 
huge. The average underbanked family makes about $25,000 a year 
and it spends about $2,400 a year just on interest and fees for 
basic financial services. In other words, that is nearly 10 
percent of their annual income, about the same amount that they 
spend on food.
    Now, a primary reason that they spend so much is they 
cannot get to bank branches. It is a lot harder to open a 
savings account or a checking account if there is no branch in 
your area, and banks are rapidly abandoning low-income and 
rural neighborhoods. According to SNL Financial, a research 
firm, banks are systematically closing their branches in areas 
where the median income is under $50,000 at the same moment 
that they are opening more branches in areas where the median 
income is over $100,000, and that trend is expected to continue 
in coming years.
    So, a couple of months ago, a report from the Inspector 
General of the U.S. Postal Service recommended that the Post 
Office partner with banks and credit unions to provide basic 
financial services--check cashing, small-dollar savings 
accounts. With Post Offices in every ZIP code, that would solve 
the access problem. In fact, 58 percent of Post Office 
locations are in ZIP codes with zero or one bank branches. The 
Post Office could leverage its infrastructure to ensure that 
low-income families have both access to banking services, that 
rural families have access to banking services, and that those 
services are offered at a lower price.
    So, what I want to ask is, Professor Martin, do you think 
that partnering between the Postal Service and banks and credit 
unions could be a better way to serve low-income and rural 
communities and do it at a lower cost than the current 
alternatives?
    Ms. Martin. I do actually think that this is a viable 
alternative. I think there are just a couple of things to keep 
in mind. One, in the report, the Inspector General indicates 
that a couple of sample studies or small, you know, start in a 
couple places first, see how it goes, see how the profitability 
goes. It is very important that those be started in areas 
without storefront payday loans so that there is no issue about 
the hours and those kinds of things.
    And the other thing, of course, is who will be the partners 
and what will be the rates. But, assuming that the rates will 
be cheaper, as indicated in the report, I think this is a very 
viable alternative that should definitely be pursued.
    Senator Warren. Mr. Rothstein, would you like to comment on 
it?
    Mr. Rothstein. Sure. Thank you, Senator. So, I think 
Professor Martin is right. I think the implementation phase 
would be the challenge. I think, theoretically, it makes sense, 
and it is actually done in Japan and Germany and other 
countries, which--the biggest hurdle, I think, besides 
implementation, would also be just sort of the--and we have 
heard some of those opinions just even recently, yesterday in 
Nashville and then here today, about the hostility toward the 
idea of the Government sector being involved in providing 
loans. So, I think that is the biggest hurdle.
    Senator Warren. OK. Mr. Bourke, do you wish to comment on 
this?
    Mr. Bourke. We are interested in the issue. We have not 
conducted research on it, but it is an issue we are interested 
in researching more.
    I would like to say a more general comment about why 
millions of people today are opting or looking outside of the 
banking system for something that the banking system is not 
giving them. So, I will focus specifically on some research we 
recently published about prepaid debit card usage.
    We found that the people who use general purpose reloadable 
prepaid cards, these are essentially checking accounts without 
checks. People can buy them on J-hooks in drug stores and use 
them as bank accounts. The driving factor of why people are 
using prepaid cards is to gain more control over their finances 
and to gain shelter from overdraft fees and the temptations of 
credit. People are seeking commitment devices to help them only 
spend the amount of money that they have and not get into 
trouble with credit and overdraft fees. Prepaid cards are 
giving that to them right now because, by and large, prepaid 
cards do not allow overdraft or spending more than people have.
    And what we found, interestingly, is that seven out of 
eight prepaid card users either currently have or used to have 
a bank account. So, people are actually experienced in the 
banking system and they are starting to go outside of it.
    So, whether it is the Postal Service or anything else, I 
would say this is a very important finding because we are 
seeing people looking for something that they are not getting 
from the banks, and I think we should keep this in mind when we 
are thinking about what the services are going forward.
    Senator Warren. Thank you very much. I see that my time has 
expired, and I just want to say, I think this gives us an 
opportunity to expand access, an opportunity to create some 
real competition here, and an opportunity to think more 
creatively about how it is that people of moderate income, how 
it is that people who live in rural areas get access to the 
banking services that they most need. And so I appreciate the 
comments on this.
    Thank you very much, Mr. Chairman. It looks to me like we 
have a win-win here. I would like to take advantage of it.
    Chairman Brown. Thank you, Senator Warren.
    Senator Heller.
    Senator Heller. Mr. Chairman, thank you and thanks for 
holding this hearing. I appreciate all of you being here and 
listening to you and the expertise that you bring to the table.
    Last week, the Fed Chair came out and said that one of the 
reasons that the economy is struggling to recover is because 
many households have limited access to credit, either because 
of their credit histories or the value of their homes being 
underwater. So, for many people, traditional banking products 
are not available to them, and it cannot be more true than in 
the State of Nevada right now, where, unfortunately, we need 
the Nation in foreclosures, short sales, and bankruptcies. So, 
we have alternative financing quite available in the State.
    Ms. Klein, I have a couple of questions for you. Customer 
satisfaction--what is the customer satisfaction on your 
product?
    Ms. Klein. Sure. So, we survey our customers once a month 
for all of Enova's products. We consistently see greater than 
90 percent satisfaction. We also see that nine out of ten would 
recommend this product to a friend, and that is saying a lot 
because people do not always want to talk about credit and how 
they are accessing credit. So, customers are very grateful for 
the products we provide and very satisfied with the service.
    Senator Heller. What is your percentage of return 
borrowers?
    Ms. Klein. So, for NetCredit, because we are doing longer-
term loans and we actually just launched this business in 2012, 
I do not have a lot of data on that. Our average loan is about 
20 months. But, again, the loans are structured so that these 
customers can repay over time. I think we have talked a lot 
about the lump-sum payment. That can be difficult for some 
consumers, so we are trying to provide another option out 
there.
    Senator Heller. OK. Alternative financing--can that help an 
individual's credit score?
    Ms. Klein. Absolutely. A product like NetCredit can. So, 
typically with a payday product or a 2-week product, the 
bureaus will not accept that data. So, at TransUnion and 
Experion and Equifax, even if you wanted to report performance 
data, they will not take it. They do not see it as relevant to 
their main customer who is a bank who wants to know if they 
should write a mortgage loan or an auto loan or a student loan.
    But, with these longer-term installment loans, the bureaus 
are happy to take that data, and we now have contracts with all 
three bureaus to start reporting our data. Again, these people 
have very low credit scores. I think you quoted a 517 or so 
average. We see that same, you know, 500 to 650 range. I think, 
without these products, people have no way to build back. So, 
this can be a starting point. These installment loans can get 
people back into the system, build credit with the major 
bureaus, and that way, they can access banking products in the 
future.
    Senator Heller. Do you have any success stories? We hear 
all the horror stories. Do you have any success stories of 
people avoiding foreclosures, losing their cars?
    Ms. Klein. You know, I get emails all the time, so we 
actually have a feedback email, and I have that set to go 
directly to my inbox because I want to see firsthand the 
customer feedback, and definitely, we have customers all the 
time who email us. I would say, as our business grows, it is 
starting to be about one a day, and so I look forward to those 
emails. And people tell us, hey, this product was really a 
lifesaver. You know, without this product, I do not know what I 
would have done.
    Another thing that is interesting, everyone talked a lot 
about monthly bills, and one comment I want to make, you know, 
we do ask customers how they use the product, and sometimes 
people will say monthly bills. And then when you ask a little 
further, they say, well, you know, my mom was really sick and 
she was in the hospital and I had a lot of medical bills, blah, 
blah, blah. Now, 6 months later, I am having a hard time paying 
my rent.
    So, when people say ``monthly bills'' and you stop there 
and you do not ask, what was really the cause, a lot of times, 
we see it was unexpected expenses. But what they need the money 
for today is their rent. And so when they say monthly bills, 
what they really mean is something happened a week ago, a month 
ago, or 2 months ago that drowned my savings, and because of 
that, I now need to borrow.
    Senator Heller. Ms. Klein, thanks for you comments.
    Mr. Chairman, I have no further questions.
    Chairman Brown. Thank you, Senator Heller.
    Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chairman.
    Mr. Flores, you argued in support of, I think it is H.R. 
1566----
    Mr. Flores. Yes, sir.
    Senator Merkley. ----which essentially strips State laws. 
In Oregon, we have a 36 percent cap, and we put it in place in 
2007. Since then, the citizens of the State have the access to 
those loans that, with the up-front fees, the annualized 
interest rate may be higher, but, essentially, on a longer-term 
rollover--because you can only use the fees once--the cost is 
much, much less than before. So, they still have access to 
credit, so there is no access to credit issue here. They just 
get it at a much, much cheaper price. So, why would anyone in 
Oregon want to roll back those State provisions, as you 
suggest? Maybe you could just give one or two very short points 
of why an Oregonian would want to go from a 36 percent cap to 
no limit.
    Mr. Flores. I do not think the bill precludes that 
companies could not offer----
    Senator Merkley. There is no cap in the bill, right?
    Mr. Flores. Pardon me?
    Senator Merkley. The bill--there is no cap in the bill.
    Mr. Flores. That is correct. What I want to say----
    Senator Merkley. Why would anyone in Oregon want to go from 
a 36 percent----
    Mr. Flores. I think a national charter would not preempt 
local companies from abiding by the Oregon statute. My point is 
choice. If the customer wants to use that product, that is 
fine. But the issue is the Internet. They can go out there and 
see other products that are available, and with the advent of 
that, these boundaries, these State boundaries really have gone 
away----
    Senator Merkley. Thank you very much. I did not see 
anything in there that explained why someone would choose a 500 
percent loan and why they would want access to that when they 
have the advantage of a much lower interest rate currently.
    Ms. Klein, you said you do not offer payday loans, so I 
went to your Web site here on the old pad and it immediately 
says up-front, payday loans. Why did you testify that you do 
not offer payday loans?
    Ms. Klein. So, I believe my specific words were that I do 
not operate our payday loan business. Enova has multiple 
products. My area of expertise----
    Senator Merkley. I see.
    Ms. Klein. ----and the business that I have been running 
for 3 years is NetCredit----
    Senator Merkley. OK.
    Ms. Klein. ----which does only offer installment.
    Senator Merkley. So when I see--go to Enova and I see a 
payday loan, and I checked a 14-day loan it is 683 percent, you 
do offer payday loans, but you also offer this new product in 
installment loans.
    Ms. Klein. Correct. You know, Enova is actively moving and 
has actually transitioned several States in the past 2 years 
from payday loans to installment loans. But, we are so limited 
by State law that in some States, we are forced to offer just 
that 2-week solution, and that solution does not help people 
build credit----
    Senator Merkley. OK. All right.
    Ms. Klein. ----so, it is a shame, in my opinion, but it is 
what we have to work with.
    Senator Merkley. Thank you very much. I found it very 
interesting that when we were debating putting a cap on payday 
loans in Oregon, the same arguments were made, that, somehow, 
citizens would feel they wanted more choice, the choice to have 
interest rates that drive them into a vortex of debt and drives 
them into bankruptcy. But, amazingly, since we passed this law 
in Oregon, I have never heard one Oregonian say that they are 
unhappy with the law, because they get the same access to 
credit but at phenomenally lower rates.
    I was very struck by going to a food bank and having the 
director of the food bank say--the first thing she said to me 
was, ``Thank goodness you passed that bill, because we used to 
have a stream of people coming to the food bank who were driven 
into bankruptcy by payday loans and now we do not.''
    If we can phenomenally increase the quality of life for 
millions of people across this country, why do we not do it? We 
have done it in Oregon. Why do we not do it across this 
country? Why would we possibly consider savaging State laws 
that--State laws that have improved the quality of life for 
millions of citizens?
    I want to tell you, the main thing I am concerned about is 
the opposite, and that is the effort of folks to exploit 
loopholes to continue to offer extraordinarily high interest 
loans in States that have deliberately put caps into place. We 
heard about Ohio. Well, in Oregon we covered all consumer loans 
and, therefore, what we see is the two loopholes are basically 
Federal chartered organizations that can bypass the State laws, 
and second of all, we see online lenders who illegally take 
payments out of Oregonians' bank accounts through remotely 
generated checks and through electronic funds transfers. So, 
the SAFE Act that Senator Tom Udall and I are championing stops 
these predatory practices.
    Mr. Bourke, should not a person have control over their 
bank account in order to make sure that folks violating Oregon 
State law not just reach in and take their funds away from 
them?
    Chairman Brown. And Mr. Bourke, answer very quickly. There 
are 10 minutes left in the vote and I want both Senator 
Menendez and Senator Vitter to get close to their 5 minutes, so 
give us a quick answer.
    Mr. Bourke. Absolutely. Online lending is growing, but it 
is not growing because of State regulation. Online lending is 
at the same level in all types of States, regardless of whether 
payday loan stores are there. That is one point I wanted to 
make.
    Two, yes, we have seen in our research, and we will be 
publishing on this in the coming months, that in online lending 
especially, there is a big problem with people losing control 
of their banking accounts, being subject to unscrupulous 
lenders in some cases, aggressive debt collectors, and in some 
cases fraudsters who purchase information from lead generators.
    Senator Merkley. Thank you very much.
    Chairman Brown. Senator Menendez.
    Senator Vitter. We are not----
    Chairman Brown. I am sorry. Senator Vitter, and then 
Senator Menendez.
    Senator Vitter. Thank you, Mr. Chair. Thank you all for 
being here.
    First, I want to say that I am absolutely supportive of all 
efforts to enforce the law, Federal law, State law, to cut out 
any abuses, any predatory practices. However, having said that, 
I am very concerned that that has expanded to an overall effort 
to shut down that entire industry, whether folks are following 
the rules or not. And I have heard many documented examples of 
that that really raise my concern.
    So, I wanted to ask Mr. Rothstein and Ms. Martin in 
particular, have you heard of Operation Choke Point and do you 
think it is a broader effort and has morphed into a broader 
effort to shut down folks in that space, whether they are 
following law and the rules or not?
    Ms. Martin. I actually am not familiar with it. I am sorry.
    Senator Vitter. OK.
    Mr. Rothstein. Senator, I had never heard of it until it 
was mentioned this morning. I will say, though, that in Ohio, 
we have, as I testified earlier, we have about four different 
competing different loan acts that are being used and I think 
it would be hard to argue that the one that lenders are using 
the most in the storefronts, which is called the Ohio Second 
Mortgage Lending Act, which was designed for mortgages, makes 
sense for payday lending.
    Senator Vitter. OK. Let me go back to my concern. I have 
talked to a number of banks who have said their regulators are 
coming and telling them not to service folks in that sector, to 
stop that. And let me submit for the record an email that makes 
this point. This is from a bank to a customer who is in that 
business, and the relevant part is this. Quote, ``Based on your 
performance, there is no way we should not be a credit 
provider. Our only issue is, and has always been, the space in 
which you operate. It has never been the service that you 
provided or the way you operate. You have obviously done a 
brilliant job. It is the scrutiny that you and now that we are 
under,'' close quote. So, I would ask to submit this for the 
record.
    Chairman Brown. Without objection, so ordered.
    Senator Vitter. I also submit for the record a similar 
email, again, from a bank to a customer, saying, we cannot work 
with you anymore. And it gets the same message across in 
somewhat more scrubbed, less direct language.
    Do you support regulators pushing banks to not service 
anyone in that space, irrespective of whether their customers 
in that space are following the rules or not? Mr. Rothstein.
    Mr. Rothstein. Yes. So, Senator, the----
    Senator Vitter. It is a yes or no, and you can elaborate--
--
    Mr. Rothstein. I just want to make sure I understand your 
question.
    Senator Vitter. Yes.
    Mr. Rothstein. So, you are asking, do I support the 
restriction of capital----
    Senator Vitter. Do you support regulators pushing their 
regulated banks to cutoff credit to these customers, 
irrespective of whether these customers in that particular 
space are following the law, following the rules, or not?
    Mr. Rothstein. I would have to look at it more.
    Senator Vitter. So that is a close question to you.
    Mr. Rothstein. I just would have to look at the issue----
    Senator Vitter. Ms. Martin.
    Ms. Martin. Yes, I am really not sure, either, because I do 
not know--without any facts, I cannot answer it. Sorry.
    Senator Vitter. Well, it was a pretty straightforward 
question. I find it very troubling that banks are being 
strongarmed to cutoff credit, to cutoff a lifeline to these 
businesses, even if these businesses are following the law. 
There is no issue in these two cases and many other cases that 
they are not following the law, they are not following the 
rules. There is a determined effort from DOJ to the regulators 
to simply cut people out of that space, to cutoff their credit, 
to use other tactics to force them out of business.
    I find that deeply troubling, in part because it has no 
statutory basis and no statutory authority. We have rules. We 
should have rules. Maybe we need additional rules--we should 
debate them--about preventing any abuse, any predatory 
practices, et cetera. These are cases that do not involve any 
of that.
    Thank you.
    Chairman Brown. Thank you, Senator Vitter. The basis is 
safe and sound practices, ultimately, and I would think that is 
where the regulators are looking here.
    Senator Menendez.
    Senator Menendez. Thank you, Mr. Chair. I think this is an 
incredibly important hearing.
    I have many of the concerns some of my colleagues have 
expressed, but I also look at the FDIC report that says that 
one in 12 American households is unbanked, meaning they do not 
have a checking or savings account at an insured depository 
institution. One in five American households is considered 
underbanked, meaning they have access to a deposit account, but 
they also rely on alternative financial services, such as 
nonbank check cashing or lending places. Together, these groups 
account for about 34 million households, about 61 million 
adults. That is about 20 percent of the American population.
    So, while I am concerned about their access to credit and 
to capital and to be able to get access to the monies that they 
need to get by and the terms under which they borrow, I am 
mostly concerned that I have not heard any real meaningful 
efforts to create the access that these individuals need. I 
have heard reforms to the existing system, but I have not heard 
about alternatives, and that is concerning to me.
    The other thing that is concerning to me is that I know in 
my home State of New Jersey, in fact, we have thousands of 
people who go online to borrow money, but these are entities 
that are offshore, which means there is no regulatory process 
in the United States that is supervising that.
    So, Mr. Flores, with reference to that legislation that 
exists over in the House about creating a national charter for 
online short-term loans, what would that do both to the 
question of those who are offshore and the question of access 
to credit for people?
    Mr. Flores. Well, I think it would certainly help eliminate 
that offshore unlicensed question. But to your point on folks 
in New Jersey, the analysis we did of the 60 million 
applications, the top ten States are 20 percent of the States 
in the country, 56 to 63 percent of applications came from 
those top ten States. Five of those States, including New 
Jersey, New York, North Carolina, are States that prohibit or 
limit payday loans or other short-term credit. So, the demand 
is there. As you are saying, people are going online, looking 
for the product.
    I think a national product with defined rules and 
regulations will benefit consumers such as your constituents in 
New Jersey and others where State law inhibits their ability to 
gain access to credit.
    Senator Menendez. Ms. Klein, what is--I think we have a 
good understanding of traditional short-term or payday lending 
models that have existed in States for years, but I am curious 
to know of any innovations to changes to loan products that may 
create more flexibility for consumers and at the same time help 
them to build credit histories that will move them toward more 
mainstream banking. Is there anything that your company does, 
or are you aware of others in the industry? And I am happy to 
listen to others, as well.
    Ms. Klein. Absolutely. Thank you for that question. And I 
really think the NetCredit product that Enova offers 
exemplifies what you are looking for. So, we have risk-based 
pricing. It is not a one-size-fits-all model. We can actually--
we have the analytics and we have put the technology in place 
to distinguish high risk from low risk and price accordingly. 
We are giving customers the control to customize their payment 
amount, and again, in real time, as they change. If they want a 
lower payment, they see that tradeoff of it is going to take 
you longer to pay back and you are going to pay a higher total 
cost. So, giving the consumer transparency, power, control over 
designing their loan.
    Credit building that you hit on is one of the most 
important pieces, and again, these short-term products that are 
2 weeks, I think they serve a place in the marketplace for some 
people. I think they are an appropriate product if someone can 
afford to pay back in full. We have seen a lot of data that 
that is not the case for everyone. And so for those consumers 
who are looking for larger loan amounts and longer term, a 
product like NetCredit would be great.
    The issue is, we are only in 12 States today. There are 
more States where you can offer a viable payday product that 
everyone here is saying is not ideal for a lot of people than 
States where you can offer a product like NetCredit that can 
build credit.
    Senator Menendez. Realizing that we have a vote on, I am 
going to yield the balance of my time so that my colleague----
    Chairman Brown. Thank you.
    If you want to do one question, Senator Moran. Thanks for 
the work on prize-link savings you are doing, and, I mean, one 
really quick question, because the vote is imminent.
    Senator Moran. Mr. Chairman, thank you very much. I was not 
expecting you to be so considerate, but this hearing is 
important. I have three going on at the same time this morning.
    But I wanted to, in listening to Senator Vitter, I would 
associate myself with his remarks. I do not understand why 
Members of Congress do not see this action by DOJ and banking 
regulators as a terrible intrusion upon Congressional 
authority. If there is a problem in this space, as Senator 
Vitter said, this is a matter to bring to Congress and for us 
to determine what the laws should be, what the regulation 
should ultimately result from that law. And so I miss the days 
in which there were Members of Congress who spoke for the role 
of Congress in making policy decisions as compared to deferring 
to regulators, and particularly in this case, to a regulator 
who is using their tremendous authority over financial 
institutions to choke off access to credit to an industry that 
is currently legal.
    So, this whole thing just is terribly troublesome to me on 
a broad philosophical point of view, and I would say that we 
have agreed to sponsor legislation for Federal regulation of 
this industry if we can find colleagues in this Committee and 
elsewhere to join with us in that effort, and so if there is a 
problem, let us make certain that Congress plays its 
Congressional role.
    Mr. Chairman, thank you for the opportunity to speak.
    Chairman Brown. Thank you, Senator Moran.
    Thank you to the whole panel. The vote is imminent, and 
Senator Moran and others, including I will do the same, will 
submit questions to you, and please get to us the answers as 
quickly as you can. Thanks for your input, and a good hearing. 
Thank you.
    The Committee is adjourned.
    [Whereupon, at 11:18 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                PREPARED STATEMENT OF G. MICHAEL FLORES
          Chief Executive Officer, Bretton Woods, Incorporated
                             March 26, 2014
    Good morning, Chairman Brown, Ranking Member Toomey, and Members of 
the Subcommittee. I am grateful for the opportunity to speak with you 
today on the issues of consumer credit and discuss the results of a 
study my firm recently completed on the customer and loan usage 
characteristics of online short term loans.
    I have worked in banking and consulting for more than 30 years and 
in the past 15 years I have conducted research short-term consumer 
credit including overdrafts and payday loans and studied prepaid cards 
for the last 6 years. I am also on the faculty of the Pacific Coast 
Banking School at the University of Washington where I teach a retail 
banking course.
    Based on my most recent research which was commissioned by the 
Online Lenders Alliance and analysis of other studies, the need for 
short-term, low dollar products is real and the demand is growing.
    The Center for Financial Services Innovation estimates the 
underbanked annual demand for unsecured short-term credit to be more 
than $61 billion with:

    Overdrafts accounting for $8.3 billion (from a total of 
        $38.3 billion in total overdrafts extended);

    Deposit advance of $4.3 billion which, in my opinion, will 
        now move to overdrafts given the exit from this market by six 
        large banks;

    Internet payday of $18.6 billion and Storefront payday 
        equaling $30.1 billion.

    The intent of the study was to:

    Build a first of its kind analysis within the industry to 
        understand the data that is currently available from the 
        specialty credit bureaus and lenders;

    Understand the strengths and weaknesses of the currently 
        available data;

    Establish a baseline from which an annual update is 
        planned;

    Catalogue and understand customer demographics and loan 
        characteristics;

    Compare this data with all other available data including 
        the Pew study and the CFPB report on storefront lending in 
        order to add information to the discussion.

    We analyzed:

    60 million application records and nine million loan 
        records from three specialty credit bureaus for a 4-year period 
        beginning in 2009.

    Because of certain constraints in the credit bureau data, 
        we augmented this with 1.6 million customer records from three 
        lenders and four loan portfolios.

    The key findings track closely with Pew and CFPB with a few 
        exceptions:

      Customer median age is 39 with an annual income of 
        $30,000 and is primarily paid bi-weekly;

      The average loan amount was $388 with a range from $300 
        to $500 with the average loan amount increasing each year from 
        $380 in 2009 to $530 in 2013;

      The annual number of loans ranged from two to four with 
        the 30 percent of the customers with only one loan;

      The annual days' indebted range from 70 days to 106 days 
        as compared to the Pew research of 144 days and the CFPB 
        storefront analysis indicating 199 days of indebtedness.

      Finally, the loan performance data from the credit 
        bureaus indicate that 71 percent of loans were reported as paid 
        and 89 percent had no charge-off flag.

    I believe the growth of the loan amount as well as the intensity of 
usage measures has led to an important trend in the industry's move 
from a 2 week product to an installment product with longer terms.
    These installment loans should be less expensive than the 
traditional 2 week product. That said, there is still value in the 2 
week product because it fits into a continuum of credit services and is 
usually less costly than overdrafts which are less costly than returned 
NSF items.
    Innovative companies, many of them operating exclusively on the 
Internet, are trying to design flexible products to meet that demand. 
The emergence of peer to peer lending is another example of this trend.
    In my discussions with many of these companies, they say real 
innovation is limited because of the patchwork of legacy State laws 
governing access to short-term credit products.
    Federal law is needed to establish the rules and regulations 
necessary to provide access to credit for consumers nationwide and 
allow companies the regulatory certainty they need to meet this growing 
credit need and to innovate and drive down costs. H.R. 1566 is designed 
to address this concern. The bill may need some work, but it has close 
to 50/50 bipartisan support in the House and offers the best current 
vehicle in Congress to help consumers.
    Thank you for your time and I look forward to answering your 
questions.
                                 ______
                                 
                 PREPARED STATEMENT OF STEPHANIE KLEIN
       Director, NetCredit Consumer Lending, Enova International
                             March 26, 2014
    My name is Stephanie Klein, and I am a Director of Consumer Lending 
for Enova, a global leader in online financial services headquartered 
in Chicago. Thank you for the opportunity to share Enova's experience 
before this Committee.
    Senators, I am here to tell you about the exciting new credit 
solutions we have been developing, what we have learned, who we are 
serving, and how we can help underserved consumers have equal access to 
quality credit. We believe we can change the dynamics in the industry 
and provide a pathway toward upward mobility that will benefit millions 
of hardworking Americans who have been left behind by traditional 
Banks.
    At Enova, since our launch in 2004, we have been using advanced 
technology and analytics to create products that meet consumers' 
evolving credit needs. I oversee NetCredit, one of Enova's newest 
installment loan products for U.S. consumers. With NetCredit, customers 
can borrow 1 to 10 thousand dollars and pay back in fully amortizing 
installments over 6 to 48 months. Payment amounts are typically just 6 
to 8 percent of gross paycheck. We derived this ratio through rigorous 
testing, but we have also released a new tool where customers can vary 
their payment amount and see the impact on total duration and total 
cost of borrowing in real-time.
    Our customer demographic presents a unique challenge when it comes 
to pricing. While our customers typically have moderate incomes, 
usually ranging from 40 to 60 thousand dollars per year, they also have 
very low credit scores. Compared to the average U.S. FICO score of 689, 
90 percent of NetCredit customers score below 650, and the majority 
fall well below 600. In short, we are serving very high-risk borrowers 
who traditional Banks are not willing or able to serve.
    Our answer to this challenge is a unique risk-based pricing 
algorithm. By leveraging multiple data sources and evaluating hundreds 
of variables, we've been able to successfully distinguish high-risk 
customers from low-risk customers and price accordingly. As a result of 
this innovation, our average interest rates are 50 percent lower than 
other leading online lenders and almost 75 percent lower than a typical 
payday loan product. Furthermore, because we use the simple daily 
interest method, customers can save money by making early payments when 
they have extra funds. In fact, roughly one-third of our customers 
choose to pay off their loans early.
    Over the past 2 years, we've been working hard to foster 
relationships with the major credit bureaus and have dedicated 
significant resources to building the technology necessary to report 
performance data. We are very excited to help our customers build 
credit history in order to achieve a brighter financial future.
    Now that I've told you about one example of how Enova is innovating 
and the benefits we can offer our customers, let me tell you about the 
significant challenges we face due to the current regulatory landscape. 
It is our belief that the current State laws do not adequately serve 
consumers. Instead of working toward innovative solutions that can be 
scaled across 50 States, we are forced to develop new products for 
individual States within the constraints of antiquated consumer credit 
statutes that were not drafted for current technologies or Internet 
lending. In many cases, instead of allowing customers a choice of 
quality credit options, current State law forces borrowers into single 
payment loans.
    Our mission at Enova is to create high-quality, innovative products 
that can not only serve an immediate credit need, but can also help 
consumers achieve a better financial future. We have proactively shared 
our experience with groups like Center for Financial Services 
Innovation and the CFPB's Project Catalyst in an effort to promote 
policies that will help working families throughout the country achieve 
equal access to quality credit. We envision uniform Federal standards 
that enable innovation to meet the needs of today's increasingly 
mobile, tech-savvy consumers.
    I encourage you to support legislation to modernize our laws. Thank 
you, Chairman Brown and Committee Members, for permitting me to present 
this testimony. I would be happy to answer any questions you may have.
                                 ______
                                 
                   PREPARED STATEMENT OF NICK BOURKE
Director, Safe Small-Dollar Loans Research Project, The Pew Charitable 
                                 Trusts
                             March 26, 2014
    Chairman Brown, Ranking Member Toomey, and Members of the 
Subcommittee, thank you for the opportunity to join in your discussion 
about alternative financial services. My commentary will focus mainly 
on small-dollar loans, including payday and installment loans. Also 
included below are observations based on Pew's latest research about 
general-purpose reloadable prepaid debit cards.
    As the director of the small-dollar loans project at The Pew 
Charitable Trusts, \1\ I appreciate the opportunity to engage with you 
on these important consumer finance issues. The following comments are 
informed by in-depth research that Pew has conducted over the past 3 
years. This research includes nationwide telephone surveys 
(representative of all payday loan borrowers, \2\ and all prepaid card 
users), more than a dozen focus groups with consumers across the 
country, a case study of Colorado's legislative decision to replace the 
conventional 2-week single-repayment payday loan with a 6-month 
installment loan, and other analysis.
---------------------------------------------------------------------------
     \1\ The Pew Charitable Trusts is a nonprofit, research-based 
organization. Our work includes providing research and analysis to help 
ensure a safe and transparent marketplace for consumer financial 
services. We conduct research that identifies the needs, perceptions, 
and motivations of those who use payday and similar loan products, as 
well as the impact of market practices and potential regulations.
     \2\ Pew's telephone survey followed the highest methodological 
standards, including random digit dialing (RDD) to fixed-line and 
mobile phones in every State, a minimum of six attempts per phone 
number, and inclusion of Spanish speakers. The survey initially 
screened 49,684 respondents to identify a sufficient number of people 
who had reported using a payday loan (both storefront and online 
cohorts were established). Depending on the question, between 451 and 
703 payday loan borrowers completed the in-depth opinion survey. The 
margin of error for usage and demographic data from the survey is 0.2 
percentage points. For the in-depth opinion research, the margin of 
error is between 4.2 and 4.6 percentage points, depending on the 
question.
---------------------------------------------------------------------------
I. Small-Dollar Loans (Payday and Installment Loans)
    Pew has published three full-length reports in our Payday Lending 
in America series, as well as various summaries, all available at 
www.pewtrusts.org/small-loans. Data discussed throughout these comments 
are based on Pew's research as well as analysis of industry and 
regulatory data, unless otherwise noted. For your convenience, I have 
appended to these comments a two-page summary of key findings from our 
payday and small-dollar loan research, and a copy of Pew's policy 
recommendations for reform in this market.
Background: Payday Loans and the Financially Fragile, ``Thick-File'' 
        Consumers Who Use Them
    Thirty-five States allow conventional payday loans, and 
approximately 12 million Americans use payday loans annually. These are 
loans usually due in full on the borrower's next payday and secured by 
a postdated check or authorization to debit a checking account. The 
loans average $375, have a term of about 2 weeks, and carry an average 
fee of about $55 per pay period. The median borrower keeps a loan out 
for 5 months of the year and spends $520 on finance charges to 
repeatedly borrow the same $375 in credit.
    Most payday borrowers (69 percent) in Pew's national survey 
reported that they turned to the loan to get money to pay ordinary 
living expenses, including rent, utilities, and credit card bills. Only 
16 percent of borrowers used the loans for an unexpected expense, like 
a car repair or medical emergency.
    The research paints a vivid picture of ongoing financial struggle. 
Six out of ten borrowers report that they have trouble paying bills at 
least half the time, with one quarter of all borrowers reporting that 
it is difficult to pay bills every month. Such persistent difficulty 
often leads to desperation. Thirty-seven percent of payday borrowers 
say that they have been in such a difficult situation that they would 
take any payday loan, on any terms offered. People who are facing such 
dire financial circumstances report feeling grateful to receive payday 
loans, which usually require little paperwork. Yet most also say that 
the loans take advantage of them.
    While it is true that payday loan borrowers have few credit options 
available to them, it is not because they lack access to the mainstream 
credit market. Rather than being ``thin-file'' or ``no-file'' consumers 
who are creditworthy but unable to find lenders willing to do business 
with them, most payday loan borrowers are ``thick-file'' consumers who 
have substantial (negative) experience with debt. In other words, 
payday borrowers are not trying to get into the mainstream credit 
system; they are failing out of it.
    Typical payday loan applicants have poor credit scores in the low 
500s, \3\ indicating an assessment by credit reporting agencies that 
they are already overburdened with debt and/or struggling to meet 
financial obligations. More than half of payday loan applicants carry 
credit card debt, two in five payday borrowers own homes (many with 
mortgages), and many also hold other debt. Most payday borrowers also 
pay overdraft fees, and this fact is a reminder that payday loans do 
not eliminate the risk of overdrafting. \4\
---------------------------------------------------------------------------
     \3\ Neil Bhutta, Paige Marta Skiba, and Jeremy Tobacman, ``Payday 
Loan Choices and Consequences'', Vanderbilt Law and Economics Research 
Paper, no. 12-30 (2012), http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=2160947.
     \4\ Pew's survey shows that most payday borrowers have overdrafted 
in the past year. See also Consumer Financial Protection Bureau, 
``Payday Loans and Deposit Advance Products: A White Paper of Initial 
Data Findings'' (2013), http:// files.consumerfinance.gov/f/
201304_cfpb_payday-dap-whitepaper.pdf.
---------------------------------------------------------------------------
Loan Payments Average One-Third of a Borrower's Next Paycheck--An 
        Unaffordable Burden
    When a payday borrower gets a loan, he or she usually uses it to 
help pay rent, utilities, or other bills. The loan temporarily solves 
these problems. However, on the borrower's next payday, the full amount 
of the loan--plus the fee--is due. For an average storefront loan, the 
amount due on payday is $430. For someone who makes $31,000 per year, 
the median payday borrower's income nationwide, $430 represents 36 
percent of his or her bi-weekly income, before taxes. By contrast, 
Pew's research has found that most borrowers cannot afford to pay more 
than 5 percent of their pretax paycheck toward a loan payment while 
still meeting their other financial obligations.
    Sacrificing one-third of their paycheck to repay a payday loan 
makes it harder for borrowers to pay their regular bills. Consequently, 
most renew or quickly reborrow a loan to make ends meet, with many 
retiring their debt only after a cash infusion, like a tax refund or 
assistance from family or friends, to repay the loan. While the loans 
are marketed as short-term fixes, they are usually experienced as long-
term burdens. The average borrower carries payday loan debt for five 
months of the year, and most borrowing is consecutive (three-quarters 
of all payday loans originate within one pay period of a previous 
loan).
    Lenders' profitability relies on this repeated usage. Industry 
analysts estimate that customers do not become profitable to payday 
lenders until they have borrowed four or five times. \5\ Researchers at 
the Kansas City Federal Reserve found that ``the profitability of 
payday lenders depends on repeat borrowing,'' \6\ a sharp contrast to 
official statements from the industry that payday loans are not meant 
as a long-term solution. \7\ In Pew's analysis, lenders' reliance on 
long-term borrowing behavior indicates a fundamental flaw in the 
business model that can only be addressed by requiring loans to be 
structured differently (mainly, as installment loans).
---------------------------------------------------------------------------
     \5\ David Burtzlaff and Brittny Groce, ``Payday Loan Industry'' 
(Stephens Inc., 2011), 15.
     \6\ Robert DeYoung and Ronnie J. Phillips, ``Payday Loan 
Pricing'', (Federal Reserve Bank of Kansas City, Economic Research 
Department, February 2009), 7, http://www.kansascityfed.org/PUBLICAT/
RESWKPAP/PDF/rwp09-07.pdf.
     \7\ Community Financial Services Association of America, ``Is a 
Payday Advance Appropriate for You?'' accessed Sept. 20, 2013, http://
cfsaa.com/what-is-a-payday-advance/is-a-payday-advance-appropriate-for-
you.aspx.
---------------------------------------------------------------------------
    The required lump-sum payment far exceeds the borrower's ability to 
repay, yet lenders maintain profitability by relying on some unique 
benefits granted to them by State laws. Payday lenders have the legal 
power to withdraw payment directly from borrowers' checking accounts on 
their next payday, prompting those without enough money left for rent 
or other bills to repay the loans and quickly reborrow, effectively 
paying an interest-only fee to reset the due date to the next payday. 
This extraordinary form of loan collateral, which is achieved through 
use of postdated checks or electronic access to borrowers' checking 
accounts, acts as a ``super lien'' against the borrower's income stream 
that allows lenders to thrive even as they make loans to those who 
cannot afford them. This power to capture borrower income enables 
lenders to make small-dollar loans without underwriting them to ensure 
that the borrower can both repay the loan and meet other financial 
obligations without having to borrower again to make ends meet.
The Lump-Sum Payday Loan Is a Failed Product
    Policy discussion in recent years has focused on whether payday 
loan customers need more access to credit, and what rate of interest is 
appropriate for such loans. These are valid questions, but there is 
insufficient evidence to know whether consumers are better off with or 
without access to high-interest loans (even if the loans have 
affordable payments).
    There is, however, sufficient evidence to conclude that 
conventional lump-sum payday loans harm consumers compared with loans 
that have affordable payments. It is clear that the lump-sum payday 
loan has inherent structural flaws that make it unaffordable and 
dangerous for consumers, and that new policies to eliminate this 
harmful product are warranted. Pew's research and analysis show that 
clearly, and just this week the Consumer Financial Protection Bureau 
(CFPB) released a new white paper \8\ with yet more proof that the 
lump-sum payday loan is a failed product. The CFPB's analysis of 
millions of payday loan records vividly demonstrates that the payday 
loan is not the short-term product that it claims to be, and that 
costly, long-term borrowing is the rule and not the exception. The 
report also shows that anything short of fundamentally reforming how 
small-dollar loans are structured would be an inadequate policy 
response to these problems. Overall, the CFPB's latest report sets a 
high bar for what the policy solution needs to be, and it leaves little 
doubt that the CFPB should require an ability to repay standard for the 
small-dollar loan market. Pew's research shows that such reform would 
eliminate the worst problems in this marketplace without significantly 
impacting access to credit.
---------------------------------------------------------------------------
     \8\ The Consumer Financial Protection Bureau, ``CFPB Data Point: 
Payday Lending'' (2014), http://files.consumerfinance.gov/f/
201403_cfpb_report_payday-lending.pdf.
---------------------------------------------------------------------------
Pew's Policy Recommendations for the Small-Dollar Loan Market (Payday 
        and Installment Loans)
    Pew has called on policy makers to act urgently, and take one of 
two approaches to addressing this problem. Policy makers can choose to 
prohibit high-cost payday loans altogether (as 15 States have done), or 
permit them only with substantial structural reforms to ensure the 
loans have affordable payments and follow a few sensible safeguards to 
ensure a safe and transparent marketplace.
    To support the CFPB and other policy makers, Pew has proposed five 
regulations for reforming payday loans. These rules will minimize harm 
to consumers and make all small-dollar loans more affordable. To ensure 
an effective and simplified regulatory environment for all lenders, 
these recommendations are intended to apply to all small-dollar loans, 
including payday and installment loans, with the exception of pawn 
loans. What follows is a summary (detailed recommendations are 
attached).

  1.  Limit payments to an affordable percentage of a borrower's 
        income. Monthly payments above 5 percent of monthly pretax 
        income are unaffordable for most borrowers. Loans requiring 
        more should be prohibited unless rigorous underwriting shows 
        that the borrower can repay the loan while meeting other 
        financial obligations.
      This recommendation is intended to provide a clear yet flexible 
        ability-to-repay standard, one that may accommodate lenders by 
        providing for a low-cost and streamlined underwriting process 
        while requiring most loans to be restructured as affordable 
        installment loans (as opposed to unaffordable lump-sum 
        repayment loans). Such a standard is flexible, easily 
        accommodating various levels of income, pricing, and loan size.

  2.  Spread costs evenly over the life of the loan. Front-loading of 
        fees and interest should be prohibited. Any fees should be 
        spread evenly over the life of the loan, and loans should have 
        substantially equal payments that amortize smoothly to a zero 
        balance.
      This recommendation addresses a common problem found in 
        installment loan markets intended to serve those with damaged 
        credit histories. When origination fees or other front-loaded 
        charges make the first month of a loan substantially more 
        profitable for the lender than subsequent months, lenders have 
        an incentive to encourage borrowers to refinance loans. When 
        loans are frequently refinanced, borrower costs increase 
        dramatically, lenders can mask defaults by inviting struggling 
        borrowers to skip a periodic payment in exchange for forfeiting 
        previously repaid principal, and the overall length of 
        indebtedness can extend indefinitely.

  3.  Guard against harmful repayment or collections practices. Policy 
        makers should prevent or limit the use of postdated checks and 
        automatic withdrawals from borrowers' bank accounts. They 
        should also make it easier to cancel automatic electronic 
        withdrawals and protect against excessively long loan terms.
      This recommendation is focused on protecting borrower checking 
        accounts by ensuring that borrowers have the power to stop 
        payments or close accounts to avoid unscrupulous or fraudulent 
        lenders. It also recognizes that some small-dollar loans could 
        have affordable periodic payments yet require repayment terms 
        that last an unconscionably long time unless policy makers 
        require shorter terms or ensure that each periodic payment 
        includes a substantial principal reduction.

  4.  Require concise disclosures of periodic and total costs. Loan 
        offers should clearly disclose, with equal weighting: the 
        periodic payment schedule, the total repayment amount, the 
        total finance charge, and the effective annual percentage rate 
        (APR) inclusive of all fees.
      To make good decisions, borrowers need clear and reliable 
        information.

  5.  Continue to set maximum allowable charges. Almost every State 
        sets maximum allowable rates on some small-dollar loans because 
        these markets serving those with poor credit histories are not 
        price competitive. Policy makers may limit rates to 36 percent 
        or less if they do not want payday lenders to operate, or 
        somewhat higher if they do.
Research Shows Safeguards Can Work: A Case Study From Colorado
    In 2010, Colorado lawmakers agreed that the State's 18-year 
experiment with conventional payday lending had led to unintended and 
harmful consequences. They dramatically changed the State's payday loan 
law, shifting from allowing lump-sum repayment loans due in full on the 
borrower's next payday to requiring that borrowers be allowed at least 
6 months to repay the loans. This major change provided a research 
opportunity to study the small-dollar loan market and its impact on 
borrowers before and after the law change. Pew's report, Payday Lending 
in America: Policy Solutions (2013), discusses the Colorado case study 
in detail.
    Colorado's experience with their new payday loan law demonstrates 
that reforms such as those listed in Pew's policy recommendations are 
viable for both borrowers and lenders. There are at least eight clear 
benefits of Colorado's structural payday loan reform:

  1.  Borrowers maintained access to credit;

  2.  Lenders are still in business (half of stores still open in 
        locations throughout the State);

  3.  Loan payments are more affordable (4 percent of paycheck now vs. 
        38 percent before);

  4.  The average borrower spends less ($277 now vs. $476 before);

  5.  Lender-charged bounced check fees are down 57 percent;

  6.  Defaults per year have declined 30 percent;

  7.  Making the loan safer and more affordable reduced the amount of 
        oversight required to ensure consumer safety;

  8.  Credit counselors and elected officials report fewer people 
        coming to them with payday loan problems.
Payday Borrowers Want Policy Makers To Act
    On a final note regarding small-dollar loans, borrowers 
overwhelmingly want policy makers to act. Pew's nationally 
representative survey shows that, by a 3-to-1 margin, payday loan 
borrowers want more regulation of this market. Most borrowers favor 
requirements that would restructure payday loans into installment loans 
with more affordable payments. For example, eight in ten favor a 
requirement that loan payments take up only a small amount of each 
paycheck. \9\
---------------------------------------------------------------------------
     \9\ The Pew Charitable Trusts, ``Payday Lending in America: Policy 
Solutions'' (2013), 22, http://www.pewstates.org/research/reports/
payday-lending-in-america-policy-solutions-85899513326.
---------------------------------------------------------------------------
II. Prepaid Debit Cards and Why Some Consumers Are Turning Away From 
        Banks
    The following section highlights findings from recent Pew research 
about general-purpose reloadable (GPR) prepaid debit cards. GPR prepaid 
cards act like checkless checking accounts and are available from a 
wide range of companies, including many nonbank, alternative financial 
services providers as well as an increasing number of bank providers.
    Millions of Americans are turning away from banks for some or all 
of their financial needs, because nonbank products are providing 
something most banks are not. A key finding from Pew's consumer 
research in the prepaid card market is that for many consumers, what 
they are seeking is better control over their finances--including 
safety from overdraft fees and security against overspending and the 
temptations of credit. Attempts to serve these consumers will be more 
successful if they are designed to help achieve these goals, and 
regulators should help ensure that consumers can successfully achieve 
the control and security that they seek. As explained further below, 
Pew's research has led us to conclude that GPR prepaid cards should not 
have overdraft or other automated or linked credit features, and that 
the CFPB should prohibit such features.
There Is a Large and Apparently Growing Group of Consumers Who Have 
        Used the Banking System But Are Going Outside of It for Some or 
        All of Their Financial Services Needs
    Nationwide, 88 percent of GPR prepaid card users either have or 
used to have a checking account (59 percent of all prepaid users 
currently have a checking account). In other words, the vast majority 
of people who use prepaid cards have experience with bank accounts but 
have opted to go outside the banking system for some or all of their 
financial services. \10\ (The prepaid card market is growing rapidly; a 
short summary of who uses prepaid cards is attached at the end of this 
comment letter.)
---------------------------------------------------------------------------
     \10\ The Pew Charitable Trusts, ``Why Americans Use Prepaid 
Cards'' (2014), 7.
---------------------------------------------------------------------------
The Desire To Gain Control Over One's Finances--and Avoid Overdraft and 
        the Temptations of Credit--Is Leading Millions To Seek Services 
        Outside the Banking System
    The fact that so many prepaid card users have or used to have bank 
accounts raises an important question: Why are so many people looking 
for financial services outside the banking system? Pew's nationally 
representative survey data show clearly that prepaid card users are 
trying to regain control of their financial lives, chiefly by avoiding 
debt; not spending more money than they have; avoiding overdraft fee; 
and insulating themselves from the temptations of credit .
---------------------------------------------------------------------------
     \11\ Ibid., 14.
    
    
    And the reason that consumers are turning to prepaid cards to find 
this control is also clear: prepaid cards on the market today generally 
do not let consumers spend more money than they load onto the cards in 
the first place. In Pew's analysis, only eight percent of prepaid cards 
from the major national providers disclose an overdraft feature. The 
vast majority of cards explicitly disclose that overdraft is not 
possible (80 percent). \12\
---------------------------------------------------------------------------
     \12\ The Pew Charitable Trusts, ``Consumers Continue To Load Up on 
Prepaid Cards'' (2014), 9-10, www.pewtrusts.org/prepaid.
---------------------------------------------------------------------------
    Compare that to the checking accounts offered by the Nation's banks 
and credit unions, where overdraft penalty fees are ubiquitous, median 
charges are $25 per overdraft for credit unions or $35 for banks, and 
customers can typically be charged four such fees per day. \13\
---------------------------------------------------------------------------
     \13\ The Pew Charitable Trusts, ``Checks and Balances: Measuring 
Checking Accounts' Safety and Transparency'' (2013), http://
www.pewstates.org/research/reports/checks-and-balances-85899479785.
---------------------------------------------------------------------------
    A 2012 Pew survey showed that a strong majority of checking account 
holders nationwide feel that such overdraft programs are more harmful 
than helpful, and 75 percent of checking account customers said they 
would rather have a transaction declined than incur a $35 overdraft 
fee. New opt-in disclosures mandated in 2010 by the Federal Reserve 
have not resolved this situation: More than half of those who 
overdrafted since that time did not believe that they had opted in. 
\14\
---------------------------------------------------------------------------
     \14\ The Pew Charitable Trusts, ``Overdraft America: Confusion and 
Concerns About Bank Practices'' (2012), www.pewstates.org/
uploadedFiles/PCS_Assets/2012/SC-IB-Overdraft%20America(1).pdf.
---------------------------------------------------------------------------
    Together, these findings show that when consumers choose prepaid 
cards, they are often seeking--and are generally finding--shelter from 
the risk of overdraft and overspending. Unfortunately, these benefits 
of prepaid cards may not last. Prepaid card providers typically retain 
the contractual right to change terms at any time for any reason, and 
there is little or no regulatory protection against overdraft or linked 
lines of credit. The CFPB should prevent overdraft and linked or 
automated lines of credit from proliferating in this market as a way of 
preserving the ``prepaid'' nature of the product and helping preserve 
the control mechanism that has drawn consumers to adopt it. \15\
---------------------------------------------------------------------------
     \15\ For Pew's policy recommendations, see The Pew Charitable 
Trusts, ``Consumers Continue To Load Up on Prepaid Cards'' (2014), 
www.pewtrusts.org/prepaid.
---------------------------------------------------------------------------
Prepaid Card Users Do Not Want the Product To Have Overdraft or Linked 
        Credit
    Prepaid users want their cards to remain free of overdraft and 
automated or linked credit features. One driver of this sentiment is 
past experience. As noted above, the vast majority of prepaid card 
users have or used to have a bank account. Of these, 41 percent have 
closed or lost a checking account because of overdraft fees. \16\ Thus, 
it is not surprising that 63 percent of prepaid users cite ``avoiding 
overdraft fees'' as a reason for using the card, with similar 
majorities saying they use the card for ``avoiding credit card debt,'' 
and ``helping you not spend more money than you actually have.'' \17\
---------------------------------------------------------------------------
     \16\ The Pew Charitable Trusts, ``Why Americans Use Prepaid 
Cards'' (2014), 8.
     \17\ Ibid, 14.
---------------------------------------------------------------------------
    Prepaid card users view mechanisms that would allow them to spend 
more money than they have as self-defeating. They find credit options 
tempting, and got a prepaid card to help them avoid the risk of 
overspending and overdraft fees. Altogether, 71 percent of prepaid 
users say they would not like to have the ability to overdraft their 
card balance for a fee, with 69 percent rejecting linked payday loans 
and 63 percent rejecting linked lines of credit. As one prepaid card 
user said in a Pew focus group, with credit features ``it will turn 
into a credit card, and it will not be a prepaid card anymore. It will 
lose its meaning.'' \18\
---------------------------------------------------------------------------
     \18\ Ibid., 21.
---------------------------------------------------------------------------
Lessons From Prepaid
    The case of prepaid cards demonstrates that there is a large and 
rapidly growing market for nonbank transaction accounts. Most prepaid 
cards offer the functionality of a checking account (direct deposit, 
ATM access, and in most cases electronic bill pay) \19\ with one key 
distinction: no overdraft or ability to spend more than they have 
deposited. The fact that the majority of prepaid users also have a 
checking account strongly suggests that they are looking for services 
or features that banks are not providing. The strength of consumer 
opinion in favor of more control, and against overdraft and 
overspending, tells us what many consumers are looking for when they go 
outside the bank system. Yet bank checking accounts continue to place 
overdraft as a core product feature.
---------------------------------------------------------------------------
     \19\ Though prepaid cards generally have a version of deposit 
insurance and liability limits for unauthorized transactions, they are 
generally inferior to those on bank checking accounts--something policy 
makers should address. The Pew Charitable Trusts, ``Consumers Continue 
To Load Up on Prepaid Cards'' (2014).
---------------------------------------------------------------------------
    Looking forward, efforts to increase access to beneficial banking 
services must take these findings into account. Efforts that help 
consumers meet the goal of avoiding overdrafting and overspending will 
be more likely to succeed; efforts that do not take this goal into 
account or put consumers at risk will be more likely to fail. In May of 
2012, the CFPB issued an Advance Notice of Proposed Rulemaking for the 
prepaid card market. In the announcement, CFPB director Richard Cordray 
noted that, while prepaid cards serve some of the most vulnerable among 
us, the cards also have far fewer regulatory protections than bank 
accounts or debit or credit cards. \20\ When the CFPB takes the next 
step of proposing actual rules, it should ensure that overdraft and 
automated or linked lines of credit are firmly prohibited and do not 
spread into the prepaid card market.
---------------------------------------------------------------------------
     \20\ http://www.consumerfinance.gov/newsroom/consumer-financial-
protection-bureau-considers-rules-on-prepaid-cards/
---------------------------------------------------------------------------
    In conclusion, I would like to thank you for allowing Pew to take 
part in this discussion. We especially hope that Congress will use its 
influence to help the Consumer Financial Protection Bureau to achieve 
its mission of enacting a strong, broad, fair, and principles-based 
regulatory policy for the small-dollar loan market. A summary of Pew's 
recommendations for small-dollar loan rules is attached and detailed 
information is available at www.pewtrusts.org/small-loans. My 
colleagues at The Pew Charitable Trusts and I would welcome the 
opportunity for further conversations at any time.














                 PREPARED STATEMENT OF DAVID ROTHSTEIN
Director, Resource Development and Public Affairs, Neighborhood Housing 
                     Services of Greater Cleveland
                             March 26, 2014
    Senator Brown and Ranking Member Toomey, my name is David 
Rothstein, director of public affairs for Neighborhood Housing Services 
of Greater Cleveland and research fellow in the asset building program 
with the New America Foundation. I appreciate the opportunity to 
testify before you today regarding small dollar lending, most commonly 
referred to as payday lending. For more than 10 years I have researched 
small dollar lending and financial services to low-income families.
    Outlined in this testimony I hope to convey the importance of 
strong regulation around small dollar lending, particularly from the 
Federal Government, as local authorities wrestle to ensure consumers 
receive safe and affordable loan products. It is imperative that we 
look at the characteristics of the loan such as the APR interest rate 
and method of payback to assess the quality of the product.
    First, the traditional payday loan model in Ohio and alive in 
dozens of other States does not serve families well. Research of actual 
borrowers continues tell this story in numerous ways--the latest Pew 
Charitable Trust Research and day old report by the CFPB providing the 
most startling research to date. I say that it doesn't serve them well 
because the average family takes out 8 to 12 loans per year from one 
lender, typically purchasing loans in back-to-back transactions. This 
is absolutely the typical Ohio customer. This means as soon as their 
loan is repaid, they immediately reborrow to cover other expenses. This 
is also the prototypical debt cycle. Our housing and financial 
capabilities counselors indicate that most clients have loans from 
about four different stores. Keep in mind that many families cannot 
afford to pay back the principle balance of the loan in just two weeks 
let alone interest and principle. If payback does occur, other monthly 
budget items suffer such as rent, utilities, food, and car payments.
    Second, payday lenders in Ohio morphed into auto title and 
installment lenders. This is also quite typical. And also more 
expensive. Ohio's battle to reform and better regulate payday lending 
continues marking an almost 8 year conflict. In 2008, the Ohio General 
Assembly passed a bipartisan bill to curtail the interest rate, loan 
amount, and number of loans per year in Ohio. The law requires lenders 
to not sell more than four loans per person per year and not more than 
28 percent APR interest. The reduction is significant since lenders 
charge 391 percent APR interest. The day after Governor Strickland 
signed the legislation, payday lenders and their trade association 
announced that they would go to the ballot, to the voter, and try to 
reverse the law. Despite spending at minimum $10 million, they suffered 
a wide-margined defeat with voters. Yet, not a single payday lender in 
Ohio uses the law (Small Loan Act) but rather two antiquated mortgage 
lending laws to sell loans at essentially the same price, if not more, 
than before.
    Most recently, lending in Ohio expanded to include selling high 
cost loans using automobile titles as collateral. An auto title loan is 
more dangerous than a payday loan in the sense that people can and do 
lose their car once they are too far into debt. I have included a 3-
part story from the Akron Beacon Journal about a working mother of 
three who lost her car and nearly her home after this loan. Installment 
loans, the newest payday product, offered by payday lenders carry a 
similar triple-digit interest rate and use the Credit Service 
Organization law to sell loans for up to 12 months. One loan that I 
analyzed cost a borrower $5,000 to borrow $2,000 over a 12-month 
period.
    Finally, At NHS of Greater Cleveland, we practice what we preach. 
Since we advocate smart home ownership, we purchased our building in 
the recovering area of Slavic Village. Since we are notably critical of 
payday lending, we are developing two alternatives. Working with the 
innovative start-up company Employee Loan Solutions, we will be working 
with large employers to provide access to safe, underwritten, low-cost 
loans through their paycheck. The lender is a CDFI focused on providing 
low-income families with affordable financial products. The other 
program is a small dollar loan serviced and managed by NHS of Greater 
Cleveland. The intent is to comply with Ohio's payday lending law, the 
only group in Ohio to do so.
    As this Congress and the Consumer Financial Protection Bureau 
consider rules and regulations around small dollar lending, a floor on 
small dollar loans will encourage high-quality innovation.
    Lenders should be required to fully assess a borrower's ability to 
repay a loan, in full and on time, without the use of repeatedly 
cashing a check or electronically debiting an account. Just like 
mortgages or credit cards, ability to repay requirements protect 
borrowers from unsustainable debt. But when lenders have the ability to 
collect payments using postdated checks or electronic transfers, they 
know they will get paid even if it causes financial hardship or forces 
a borrower to take out another loan to pay off the first. Lenders 
should not be able to use postdated checks and electronic payments to 
access a borrower's bank account if they are unable to repay a loan. 
The litmus test is that automatic payment should be a convenience for 
the borrower not a side-step to debt collection laws.
    I appreciate your time and commitment to ensuring that low- and 
moderate-income families are best served in the financial sector. I am 
happy to answer any questions that you may have.




                 PREPARED STATEMENT OF NATHALIE MARTIN
Frederick M. Hart Chair in Consumer and Clinical Law, University of New 
                          Mexico School of Law
                             March 26, 2014
    Thank you, Chairman and Members of the Subcommittee for the 
opportunity to provide this written testimony in connection with the 
hearing entitled ``Are Alternative Financial Products Serving 
Consumers?'' Below I provide a background of my credentials, describe 
some of my research on high-cost credit, describe the different forms 
of high-cost credit, and then explain why I believe that enacting a 
Federal usury cap is the simplest and most effective way to regulate 
these forms of credit.
I. Background
My Credentials and Research
    I am the Frederick M. Hart Chair in Consumer and Clinical Law 
University of New Mexico School of Law. This endowed chair is thought 
to be the only one in the U.S. dedicated to consumer law issues. 
Although I write in other areas as well, the primary focus of my 
research is high-cost loan products (which include payday loans, title 
loans, and triple and quadruple-digit interest rate installment loans), 
and public attitudes about these forms of credit.
    My research on high-cost lending includes the articles listed 
below, which can be found at http://papers.ssrn.com/sol3/cf_dev/
AbsByAuth.cfm?per_id=1313797.

``Interest Rate Caps, State Legislation, and Public Opinion: Does the 
    law Reflect the Public's Desires?'' 89 Chicago Kent L. Rev. 1 
    (2013) (with Timothy Goldsmith).
``High-Interest Loans and Class: Do Payday and Title Loans Really Serve 
    the Middle Classes?'', 24 Loyola Consumer L. Rev. 524 (2012) (with 
    Ernesto Longa).
``The Alliance Between Payday Lenders and Tribes: Are Both Tribal 
    Sovereignty and Consumer Protection at Risk?'', 69 Wash & Lee L. 
    Rev. 751 (2012) (with Joshua Schwartz).
``Grand Theft Auto Loans: Repossession and Demographic Realities in 
    Title Lending'', 77 Missouri Law Rev. 41 (2012) (with Ozymandias 
    Adams).
``Regulating Payday Loans: Why This Should Make the CFPB'S Short 
    List'', 2 Harv. Bus. L. Rev. Online 44 (2011), available at: http:/
    /www.hblr.org/?p=1595.
``1,000 Percent Interest--Good While Supplies Last: A Study of Payday 
    Loan Practices and Solutions'', 52 Arizona Law Review 563 (2010).
``Double Down-and-Out: The Connection Between Payday Loans and 
    Bankruptcy'', 39 Southwestern L. Rev. 789 (2010) (with Koo Im 
    Tong).
My Research Progression and Empirical Findings
    I have done five empirical studies related to high-cost lending and 
attitudes toward high-cost lending.
            First Study in 2009
    I devised my first study, ``1,000 Percent Interest--Good While 
Supplies Last: A Study of Payday Loan Practices and Solutions'', after 
meeting clients in our clinical law program that had taken out the 
loans. Before meeting these clients, I had no idea what the terms of 
these loans actually were. Once I saw the 1,000 percent interest rates, 
I had to learn more. As a person who believes markets can serve people 
and respond to competition and consumer complaints, I wanted to find 
out why the rates never seemed to drop even when more lenders entered 
the market. I also wanted to find out what people were using the loans 
for and whether consumers shopped based upon the rates. Finally, I 
wanted to determine if consumers knew the loans were interest-only 
loans when they took them out. I went into the study with an open mind, 
just trying to learn the facts. In the study, published in the Arizona 
Law Review, I and my students interviewed 109 consumers outside payday 
lending stores. Key findings of this study include:
People Do Not Shop for Payday Loans on the Price So the Market Does Not 
        Reduce Cost
    People do not shop for price when obtaining a payday loan but 
instead take out loans near home or work out of convenience, or go to 
lenders that friends or family members have used. This means that the 
market forces that would usually reduce prices through competition do 
not work. Indeed, regardless of how many new lenders enter the market, 
prices only go up, never down.
Most Customers Do Not Understand the Loans Before They Get Into Them
    People have difficulty understanding the terms of the loans and are 
very surprised when they go in and make a payment of $80 on a $400 loan 
and the $80 payment does not reduce the principle on the loan at all. 
People also cannot calculate the annual percentage rate on the loan 
(for example, by multiplying the 14 day rate by 26 periods of 14 days 
within a year), and thus cannot easily compare the cost of this credit 
to other forms of credit.
    Some people thought that a rate of $15 per $100 borrowed for 14 
days (390 percent per annum) was less expensive than a credit card rate 
of 25 percent per annum. One woman was proud of herself for using these 
loans instead of student loans.
Customers' Use of the Loans
    People do not use the loans for short term needs. Many people who 
use these are in continuous debt, often with more than one loan.
    Many people reported having low cost or no cost options to taking 
out the loan, including doing without or asking a friend or family 
member. Getting the high-cost loan just seemed easier, until they saw 
how hard it was to pay back.
    People generally are not able to pay the loans back as quickly as 
they thought they would.
    People use the loans primarily for regular monthly expenses, not 
emergencies, which means these consumers are worse off the following 
month than they were before they took out the loan. They now have 
another monthly bill to pay.
            Subsequent Empirical Research
    Before I began the first study, I had no idea how many loans 
consumers carried at a time. I assumed most people used just one loan 
at a time. Discovering the use of multiple loans at a time led to my 
next study, an empirical analysis of the debts of over 1,000 bankruptcy 
debtors to determine what percentage of the debtors used payday loans 
in a State with lax regulations, and of those, how many loans the 
borrowers had. I discovered that 19 percent of debtors in the study 
used the loans, that nearly 70 percent of those with loans had more 
than one, that 37 percent had more than 5 loans, and that an astounding 
14 percent had more than 10 loans. \1\
---------------------------------------------------------------------------
     \1\ ``Double Down-and-Out: The Connection Between Payday Loans and 
Bankruptcy'', 39 Southwestern L. Rev. 789 (2010) (with Koo Im Tong).
---------------------------------------------------------------------------
    In my next study, I analyzed State data on title loans and 
discovered, among other things that title lenders do not underwrite the 
loans for affordability and that the loans create a high risk of 
repossession. \2\ I then did a demographic study of borrowers, again 
using bankruptcy data, and discovered that most payday loan borrowers 
are not middle class people as the industry suggests but that these 
borrowers typically have lower incomes than the median income in their 
State and also have lower home ownership rates than the average. \3\ 
These results have been recreated in numerous studies, including ``Do 
Payday Loans Really Serve the American Middle Class? An Empirical 
Analysis'', in a recent issue of the Journal of Consumer Affairs.
---------------------------------------------------------------------------
     \2\ ``Grand Theft Auto Loans: Repossession and Demographic 
Realities in Title Lending'', 77 Missouri Law Rev. 41 (2012) (with 
Ozymandias Adams ).
     \3\ ``High-Interest Loans and Class: Do Payday and Title Loans 
Really Serve the Middle Classes'', 24 Loyola Consumer L. Rev. 524 
(2012) (with Ernesto Longa).
---------------------------------------------------------------------------
II. Background of Topic: Terms of Various Types of High-Cost Loans
    There are many varieties of high-cost loans, a few of which are 
described here as background.
Payday Loans
    A true ``payday'' loan is called a payday loan because its original 
purpose was to help a customer survive a short-term cash flow crisis 
between the time of the loan and the customer's next payday. In one 
common form of payday loan, a consumer borrows money at a rate of 
between $15 and $25 per $100 for a period of 14 days or less. In other 
words, if a consumer was paid 4 days ago but is already out of cash, 
she can go borrow, for example, $400 between now and her next payday 
(now 10 days away). To get that $400 at the $15 per $100 rate she would 
need a checking account and would write a check, or authorize an 
automatic debit, for $460 postdated to her next payday.
    When payday comes, she can either let the check or debit clear, 
assuming the unlikely event that she now has this money, or she can go 
in and pay another $60 to borrow the same $400 for the next 2 weeks. 
When taken as an annual percentage rate, calculated by multiplying this 
rate by twenty-six 2-week periods over the course of a year, these 
terms result in an interest rate of 390 percent per annum or higher.
    Typical State payday loan laws (in States that have them) limit 
interest and fees to $15 per $100 (390 percent or more) but only if the 
loan is 14-35 days in duration. These laws do not apply to longer 
loans.
Title Loans
    Another type of high-cost loan is the auto title loan, for which 
consumers do not need bank accounts. Rather borrowers simply need an 
unencumbered automobile to secure the loan. These loans carry a typical 
interest rate of 25 percent per month or 300 percent per annum. While 
title loans typically carry lower interest rates than payday loans, 
they tend to be larger loans, increasing the chances that they will be 
difficult to repay and will create a debt trap. They also subject 
borrowers to the possibility of losing their vehicle, a risk not 
encountered with the other forms of high-cost loans.
Installment Loans
    Yet another type of high-cost loan is the so called ``installment 
loan.'' This is the new loan of choice for many lenders as these loans 
allow lenders to skirt State laws regulating loans made for 14 to 35 
days.
    The phenomenon of morphing loans into another form in order to 
avoid State laws is discussed in more detail below, but in short, 
lenders make installment loans to avoid State payday loan laws, simply 
by making loans with durations longer than 35 days. Longer loans fall 
outside the regulations and thus remain unregulated. In one such 
installment loan, a customer borrowed $100, to be repaid in twenty-six 
bi-weekly installments of $40.16 each, plus a final installment of 
$55.34. In total, this borrower paid a total of $1,099.71 on a $100 
loan. The annual percentage rate on the loan was 1,147 percent.
III. Solutions to the Problems Caused by High-Cost Loans
    There are many ways to legislate high-cost credit, but most methods 
that have been tried have failed. One method that has not failed is 
simply capping interest rates. Other possible solutions may exist, but 
each has its problems. For example, a law could be passed that would 
require that lender underwrite their loans. Lenders would need to 
ensure that borrowers could afford to make their regular monthly 
expenses and also pay back the loan. Otherwise, the loan could not be 
made. If the loan was made anyway, it would not be enforceable.
    Another middle ground would be forbidding rollovers or back to back 
loans from the same lender or different lenders, and limiting the 
number of loans a consumer could take out in a given time frame. This 
could be enforced through a national database in which all loans would 
need to be placed. A well written law would provide that if a loan did 
not appear in the database, it would not be enforceable and the lender 
could not take any action to collect it.
    Lenders dislike these options, claiming that the latter violates 
consumer privacy rights and that the former, the underwriting, is too 
complex. I agree that these options are complex. I also fear that 
lenders would find ways around compliance, similar to the loopholes 
they have used in the past. Because of these potential loopholes and 
also these complexities, I prefer a far simpler method of regulation, 
namely the implementation of a Federal usury cap.
A. There Is No Existing Federal Law on Interest Rate Caps for Loans to 
        the General Public
    There currently is no Federal law regulating interest rates on 
consumer loans. Until 25 years ago, most U.S. States had usury laws 
that capped interests on consumer loans. In the U.S., usury laws have 
historically been the main protection consumers have had against harsh 
credit practices. Usury dates back to the earliest recorded 
civilizations and has a very prominent role in early American laws.
    The Supreme Court's decision in Marquette National Bank v. First 
Omaha Service Corp., \4\ concluded that the bank's State interest rate 
applied when a bank lent to an out-of-State customer, and after this 
decision, States began eliminating their usury caps in order to attract 
financial institutions to their States, with South Dakota and Delaware 
leading the way. The decision effectively deregulated State interest 
rate caps. No Federal law has filled this gap, nor have other solutions 
to high-cost lending been designed.
---------------------------------------------------------------------------
     \4\ Marquette Nat'l Bank v. First Omaha Serv. Corp., 439 U.S. 299 
(1978).
---------------------------------------------------------------------------
B. Only About a Third of States Effectively Regulate High-Cost Credit
    Eighteen States plus the District of Columbia either forbid high-
cost lending or cap interest rates at 36 percent or less. The rest of 
the States have either no regulation of consumer loans, have 
regulations that affirmatively allow the high-cost products described 
above, or have piecemeal laws that apply to one or more of the various 
types of loans. The resulting legislative patchwork has kept 
legislatures and consumer protections organizations busy around the 
clock, but has not resulted in any overall decrease in high-cost loans 
or in interest rates on such loans. To the contrary, the high-cost 
lending industry is growing exponentially, faster than any other part 
of the consumer credit sector and rates are going up not down.
C. The Public Supports Interest Rate Caps on Consumer Loans, Even the 
        Very Conservative Public
    In every study or survey in which the public has been asked to 
comment, the American public overwhelmingly supports Government 
imposition of interest rate caps on consumer loans. A recent study I 
did with psychologist Tim Goldsmith proves this point. Our entire 
article is attached but other studies and survey all reach the same 
result.
    First, a national survey by the Center for Responsible Lending 
shows that three out of four Americans who expressed an opinion think 
that Congress should cap interest rates, and 72 percent feel that the 
caps should be no higher than 36 percent.
    State ballot initiatives glean the same results. For example, in 
Montana, 72 percent of the population supported a ballot initiative 
that ultimately resulted in a 36 percent cap on interest rates for all 
loans in Montana. Citizens of Kentucky also voted for a ballot 
initiative that ultimately capped all loans at 36 percent. Similarly, 
Arizonans overwhelmingly supported a ballot initiative that ended 
payday lending in the State. Additionally, in 2008, 68 percent of 
Ohioans supported a ballot initiative that purported to cap interest in 
the State at 28 percent.
    Public opinion survey data show similar public proclivities in 
favor of interest rate caps. After hearing that payday and title 
lenders can charge 500 percent or more in Texas, 63 percent of Texans 
age 45 or older strongly agreed that the State should cap interest 
rates and fees, with 77 percent of respondents reporting that the cap 
should be 36 percent or less. In another survey taken by the Texas Fair 
Lending Alliance, and the Texas Faith for Fair Lending, 85 percent of 
people polled favored capping interest rates on payday and auto title 
loans at 36 percent APR or less. In Iowa, survey data showed that seven 
in ten Iowans believe payday loan rates and fees should be capped. In 
Rhode Island, the only State in New England to allow storefront payday 
lending, a public opinion poll showed that 62 percent of Rhode 
Islanders supported capping interest on payday loans. Finally, a public 
poll of Coloradans showed that 74 percent of Coloradans support a 
similar 36 percent cap.
    Additionally, support for caps crosses party lines. In the attached 
study by Professor Tim Goldsmith and I, we set out to measure not just 
overall support for interest rate caps but political affiliation of 
those who favor caps on consumer loans. Our data show widespread 
support for interest rate caps across political lines. We did find that 
more Democrats favor interest rate caps than Republicans, with 94 
percent of Democrats favoring caps and 73 percent of Republicans 
favoring caps.
    What is remarkable, however, is just how many conservative people 
favor caps. Our data show that over 57 percent of people who report 
being ``very conservative'' politically and over 82 percent of those 
who report being ``conservative'' politically favor interest rate caps 
over no interest rate caps.
    While wondering aloud why the public is not more active in seeking 
out laws that cap interest, we stumbled upon a possible explanation. 
First, many people incorrectly think interest rates are capped (over 58 
percent for credit cards and over 43 percent for short-term loans), 
when in reality these rates are not capped. In other words, people 
misunderstand and overestimate the protection the law currently 
provides. Second, even among those who know that the law provides no 
caps, most are unaware that lenders in the State in which the study was 
conducted currently charge interest rates of 200 percent or more. 
Indeed, we found that 81 percent of the public was unaware of the costs 
of these ubiquitous loans. These poll data support the notion that 300 
percent to 1,000 percent loans are not normal or usual, and the public 
opposes them. Interestingly, people who had themselves used the loans 
were even more in favor of caps than nonusers.
D. Loopholes: How Lenders Get Around Every State Law That Is Passed, 
        Except Caps
    Despite wide and deep public support for rate caps, uniform State 
interest rate caps that apply to all consumer loan products are few and 
far between. Moreover, those caps that do exist are often ineffective 
due to State laws' inability to regulate certain lenders, namely online 
lenders located offshore or affiliated with Indian tribes.
    In States where complex statutes are passed to limit high-interest 
lending, even storefront lenders find ways around those laws, by 
changing the attributes of the loans to avoid the laws, fitting within 
exceptions created by other laws on the books, or becoming credit 
service organizations (CSOs), which are exempt from the laws. This 
complex game of whack-a-mole makes regulating State by State an 
expensive yet ineffective endeavor.
            1. The ``Loan Term'' Loophole
    Loopholes happen. In the world of payday lending, they happen a 
lot. For example, payday lenders began appearing in New Mexico after 
the State repealed its General Usury statute (former NMSA 1978 56-8-
11-1) in 1991. For five very long and frustrating years, the New Mexico 
Legislature debated various payday lending statutes. Finally, during 
the legislative session of 2007, the Legislature adopted a law is 
similar to those of several other States. The regulation relies heavily 
on computer database enforcement mechanism for consumer qualification 
and reporting. Thirty-three States have laws that bear some similarity 
to this New Mexico law. None, however, curb high-cost lending abuses, 
despite legislative goals of curbing high-cost loan abuses.
    The new law capped interest and fees at $15 per $100 for each 
period of 14 days or less, or 390 percent per annum or more. The new 
law also applied only to lenders engaged in the business of lending 
amounts of $2,500.00 or less, and defined a loan covered by the Act as 
one of 14 to 35 days in duration, for which the consumer gives the 
lender a check or debit authorization for the amount of the loan plus 
interest and fees.
    In the end, this narrow definition gutted the legislation. The 
industry quickly switched to loan products that fall outside the 
statute, namely longer loans or those not involving a postdated check. 
This was done so that lenders could charge more than 390 percent per 
annum and avoid the database. Naturally, these loans that fall outside 
the definition are not regulated at all. Thus, many States have spent 
years attempting to regulate payday lending, but the resulting State 
laws have done nothing to change short-term lending at high interest 
rates.
    Professor Robert Mayer reports on a similar legislative process in 
Illinois:

        Regulators in Illinois imposed rules in 2001 that were designed 
        to [curb the number of payday loans and roll-overs]. Customers 
        were allowed to borrow no more than $400; only two renewals 
        were permitted, with some of the principal paid down each time; 
        and a cooling-off period was mandated to prevent borrowers from 
        using the proceeds of a new loan to pay off the old one. The 
        State . . . promised to establish a database to track loan 
        activity and enforce the rules. \5\
---------------------------------------------------------------------------
     \5\ Robert Mayer, ``One Payday, Many Payday Loans: Short-Term 
Lending Abuse in Milwaukee County'' (working paper, 8), available at 
http://lwvmilwaukee.org/mayer21.pdf (last accessed Aug. 6, 2009).

    As in New Mexico, Illinois payday lenders quickly devised a new 
product to evade the rules. The statute applied to cash advances with a 
term of less than 31 days, so the industry created a 31-day loan not 
covered by the rules. As a result, all of the old abuses persisted.
    A 2003 Illinois OFI report acknowledged that it remains quite 
common for borrowers to have multiple payday loans outstanding with 
several different payday loan companies. Similar end runs occurred in 
Oklahoma. Additionally, other States such as Florida, Illinois, and 
Michigan have tried to impose interest-free payment plans like one 
passed in New Mexico, but these laws have produced no meaningful 
reduction in the number of trapped borrowers.
            2. Using Exceptions Created by Other Laws To Get Around 
                    State High-Cost Loan Laws
    Other forms of loopholes also abound. In 2008, the Ohio State 
Legislature voted to rescind a 12-year-old law that exempted payday 
lenders from the State's usury laws, a vote Ohioans supported two to 
one. An existing short-term loan law purported to cap interest on all 
short-term loans at 28 percent, and also to give customers at least a 
month to pay off the loans. In response, lenders simply switched their 
licenses so they could offer payday loan look-alikes under two parallel 
lending statutes, the Small Loan Act or the Mortgage Lending Act. 
Making these changes was simple for lenders and they began offering 
even higher cost loans, as this industry Web site explains:

        By adjusting the loan amount to just above $500, payday loan 
        lenders double the loan origination fees from $15 to $30. The 
        Small Loan and Mortgage Lending acts allow the fees on top of 
        the 28 percent interest, something the new payday lending law 
        doesn't permit. Under the new HB 545 licensing scheme with the 
        check cashing fees added, customers pay the same $575 to walk 
        out the door with $500 in cash . . .

        A First American payday loan customer indicated he previously 
        paid $75 for a $500 loan, First American charged him a total of 
        $90 to borrow the same amount after the law changed. More than 
        one Ohio payday loan company has structured their check cashing 
        and loan operations as two separate entities to justify the 
        fees. \6\
---------------------------------------------------------------------------
     \6\ As another industry Web page explains: With news of the 
passage of Issue 5 in Ohio on Nov. 4, Check Into Cash began 
restructuring its loan product offerings throughout the Buckeye State 
to comply with the new law. On Nov. 5, the company ceased to offer 
payday loans and began offering a new product, microloans, which are 
short-term loans from $50 to $600 and permitted under Ohio's Small Loan 
Act. These new microloans are one way that Check Into Cash is striving 
to continue to serve its valued customers with the same level of 
service as it has in prior years. Even though this new Ohio legislation 
was designed to make it difficult to continue serving customers who 
desire payday advance services, Check Into Cash has pushed ahead, 
endeavoring to persevere with its ongoing commitment to customer 
service. ``Check Into Cash Committed to Serving Ohio Customers'', PRWEB 
(Nov. 18, 2008, 10:19 AM), http://www.prweb.com/releases/checkintocash/
ohio/prweb1628414.htm), quoted in Martin, supra note 43, at 591 n. 151.

    Then Ohio Attorney General Rich Cordray said his office found 
payday loans with APR's ranging from 128 to 700 percent immediately 
after the ballot initiative that purported to cap interest on consumer 
loans in Ohio at 28 percent.
            3. Online Lending
    Internet payday lending is growing quickly and many online lenders 
claim to be immune from State laws. Even where States have won cases 
holding that online lenders must comply with State laws, lenders often 
fail to do so. State regulators have again garnered precious resources 
to enforce their laws, often to no avail. The most recent survey by the 
Consumer Federation of America (CFA) notes that lenders continue to 
claim choice of law from lax jurisdictions, to locate off-shore, or to 
claim tribal sovereign immunity to avoid complying with State consumer 
protection laws.
    The trial sovereign immunity loophole is particularly troubling, as 
it pits two traditionally disadvantaged groups, Native Americans and 
low-income consumers, against one another in a complex battle over who 
needs protection more. Under this model, lenders team up with Indian 
tribes to avoid State laws. Tribes engaged in off-reservation 
activities must comply with nondiscriminatory State laws, as must 
anybody else. Despite this requirement, tribes are immune from suit 
because they are separate sovereigns. Thus, while they must obey State 
laws, they can't be sued to enforce the laws or compel their 
compliance. This motivates lenders to seek out tribal partners as this 
industry Web site explains:

        Due to the strict regulations that are hitting the payday loan 
        industry hard, many lenders are now turning to Indian Tribes to 
        help them out. The American Indian Tribes throughout the United 
        States have been granted sovereign immunity which means that 
        they are not held subject to the laws that payday loans are 
        currently going up against. There are 12 States which have 
        banned payday lending but as long as their (sic) is an Indian 
        tribe who runs the operation on this sovereign land, the 
        lenders can continue their business even where payday loans 
        have already been banned. Similar to the Casino boom, payday 
        loans are the new financial strategy that many are using as a 
        loophole through the strict payday loan laws. The revenue is 
        quite high and promising for these tribes who often find 
        themselves struggling. There are approximately 35 online cash 
        advance and payday loan companies that are owned by American 
        Indian tribes. . . . It is no surprise that many lending 
        companies are currently seeking out American Indian Tribes in 
        an effort to save their businesses by escaping U.S. lending 
        laws. Tribal leaders are paid a few thousand dollars a month 
        for allowing a payday lender to incorporate on tribal land. The 
        more lenders that tribes allow to move onto their reservation, 
        the larger the profit that they make. \7\
---------------------------------------------------------------------------
     \7\ ``The Connection Between Indian Tribes and Payday Lending'', 
Online Cash Advance, http://www.online-cash-advance.com/financial-news/
the-connection-between-indian-tribes-and-payday-lending#ixzz1Nt1vQu6h 
(last accessed Jan. 11, 2012) (on file with the author).

    Often, as this excerpt clearly articulates, the lenders using this 
model are not tribes. Proving that the lenders are not entitled to 
tribal sovereign immunity is not easy, however. A simple Federal 
interest rate cap would eliminate this loophole as even tribes are 
bound by Federal law.
E. Colorado: A Middle Ground To Consider But Still 200 percent
    Despite all of the failures of State high-cost lending laws to 
reduce interest rates or otherwise eradicate onerous loan terms, 
Colorado has passed a law that does lower those rates somewhat. This 
law is worth studying for its possible implications for future Federal 
legislation.
    Colorado's 2010 law has reduced the number of payday loans in the 
State as well as the interest rates on existing payday loans. The law 
sets a maximum loan amount at $500 and adds provisions designed to keep 
consumers from getting trapped in the usual payday loan roll-over 
cycle. Consumers also have the right to cancel a payday loan 
transaction by 5:00 p.m. the following day. Consumers may also choose 
to repay loans in one sum or pay the full amount over 6 months. The law 
also caps interest rates for these loans at 45 percent, but this rate 
limit does not include fees and other costs, which add significantly to 
the actual cost of the loans.
    A recent study completed by the Pew Charitable Trust concludes that 
this new law has been effective in reducing rates on payday loans. \8\ 
The dollar amounts of payday loans in Colorado have fallen almost 60 
percent, and the number of loans fell from 1,110,224 loans in 2010 to 
444,333 in 2011 after the law was implemented. Data from the Colorado 
Attorney General's office indicate that the new law appears to have 
dropped average effective APRs from 338.90 percent to 191.54 percent. 
In addition, quite significantly, the average number of payday loans 
consumers have taken out per year has fallen from 8.53 loans per person 
to 2.3 loans per person.
---------------------------------------------------------------------------
     \8\ Susan K. Urahn, Travis Plunkett, Nick Bourke, Alex Horowitz, 
Walter Lake, and Tara Roche, ``Payday Lending in America: Policy 
Solutions, Report 3 in the Payday Lending in America Series'', The Pew 
Charitable Trusts, October 2013, 12-13, http://www.pewstates.org/
uploadedFiles/PCS_Assets/2013/Pew_Payday_Policy_Solutions_Oct_2013.pdf.
---------------------------------------------------------------------------
    Nonetheless, the average contract finance charge has risen 
significantly, from $60 to $237 and many consumer protection groups are 
appalled that when fees and costs are included, the Colorado law allows 
interest rates of nearly 200 percent. There also has been an increase 
in ``same-day-as-payoff'' transactions, meaning the lender makes a new 
loan to a consumer on the same day the consumer pays their previous 
loan in full. This means lenders are easily getting around rollover 
limits.
    In summary, Colorado has been more vigilant than any other State in 
working on a solution to the payday lending problem. The law it passed, 
while better than most, still has problems.
    Few States have the will or the resources to go to the efforts to 
which Colorado has, making a Federal solution to the problem efficient 
and effective by comparison. Congress has regularly and effectively 
taken over areas of consumer and commercial law and should do so here 
as well. Nevertheless, Colorado's law should be studied by Congress 
before it acts.
F. Why a Federal Interest Rate Cap Would Work Best
    Given the overall failure of States, a Federal usury cap is the 
only option that is certain to curb high-cost lending. Coordinating 50 
States on this or any issue is complex and difficult work. Congress on 
the other hand need pass just one law to accomplish a national usury 
cap. Consumers can and do cross borders to borrow money, and States 
have no particular interest in caps. Moreover, the entire country is a 
common market, such that any State's regulation of interest rates 
inherently reaches across borders. Thus, there is a need for uniformity 
on interest rates across those borders, which only Congress can 
provide.
    Congress unquestionably has the power to set Federal interest rate 
caps, through the Commerce Clause of the U.S. Constitution. Indeed, in 
recent years the regulation of consumer credit has become even more and 
more of a Federal, rather than a State, regime.
G. The Military Lending Act as a Starting Point for Congress
    Congress already has experience setting a 36 percent cap that 
protects some but not all Americans. In 2007, Congress passed the 
Military Lending Act (MLA), \9\ which purported to place a 36 percent 
interest rate cap on consumer loans and to prohibit lenders from 
engaging in predatory practices toward active-duty military members and 
their dependent family members.
---------------------------------------------------------------------------
     \9\ 10 U.S.C. 987(b) and 32 CFR 232.4(b).
---------------------------------------------------------------------------
    In passing the MLA, military lenders were deeply concerned about 
the effects of predatory lending on military readiness. When they 
realized State lawmakers were unable or unwilling to pass laws 
protecting the troops, these leaders focused their efforts on passing 
Federal legislation. In 2006, the United States Department of Defense 
issued a report finding ``that payday lending `harms the morale of 
troops and their families, and adds to the cost of fielding an all-
volunteer fighting force.' '' Congress noted that lenders were 
blatantly targeting the military by clustering in large numbers ``near 
military bases'' and using ``military-sounding names'' and also that 
military personnel lacked sophistication in financial matters and were 
easily taken advantage of.
    While there was early evidence that the MLA curbed predatory 
lending to military communities, more recent evidence suggests that 
even the MLA is mired by loopholes. However, Congress can learn from 
these loopholes and pass an effective 36 percent cap, modeled after 
effective State law caps. Congress can learn from the experience 
gleaned from the MLA and pass a law that better serves all Americans. 
Finally, the Federal Government has the power to enforce a Federal 
usury cap through the Consumer Financial Protection Bureau, whereas 
most States lack sufficient enforcement power.
IV. Conclusion
    Based upon years of research and a great deal of contact with low-
income consumers, I honestly believe people are better off without the 
option to take out unlimited numbers of high-cost loans. This is 
especially true when current law in most States allows lenders to 
charge 1,000 percent per annum or more in interest and fees. These 
forms of credit cause far more harm than good. They are not safe, not 
affordable, and thus access to them is more of burden than a benefit.
    These loans make cash flow problems worse. The two ways to 
eradicate cash constriction are to increase income or reduce costs. 
These loans increase costs and thus worsen the problem of limited 
income to meet expenses. If these loans cannot be made more affordable, 
the loans should not be made.
    Moreover, as long as these forms of credit are around, alternatives 
for low and middle income people with poor credit will not be become 
available. Where the loans are legal, high-cost lenders are everywhere, 
outnumbering Starbucks, McDonald's, Burger Kings, and Walgreen's 
combined. With no underwriting, they are easy (too easy) to borrow 
from. As long as these lenders are in business under the terms 
described here, it will be difficult for States and the Federal 
Government to develop lower cost alternatives.
    Thanks very much for reading and let me know if you'd like more 
information on any of these points.






















































        RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN
                     FROM G. MICHAEL FLORES

Q.1. Regulators have long made clear that the ability to repay 
means repaying a loan without ``loan flipping,'' i.e., frequent 
renewals or reborrowing. The Online Lenders Alliance study 
shows as many as 57 percent of customers in some cases were 
unable to pay back the loan without taking out another loan in 
the same month. This study also found that 29 percent of loans 
were not reported as ``paid.''
    What do these findings tell us about the sustainability of 
these loans?

A.1. This 57 percent metric indicates that some customers use 
the product as a monthly cash flow tool and that there are a 
smaller group of customers that are high frequency users and 
the single pay product is not necessarily best suited for their 
needs.
    The 29 percent metric is indicative of high risk borrowers. 
These may be outstanding loans that have yet to reach their 
payment data of classified as delinquent or charged-off. As 
such, higher risk equates to higher costs. In a commercial 
banking environment, 3 percent delinquency is at the upper end 
of acceptability for consumer loans (see http://
www.federalreserve.gov/releases/chargeoff/).

Q.2. Please describe how these findings may evidence that an 
ability to pay rule is needed for these types of loans.

A.2. For short-term, low dollar loans, a better criterion is 
``likelihood to repay'' rather than ``ability to repay.'' For 
loans that average $400, underwriting for ability to repay 
would significantly add to the cost and make originating these 
loans unprofitable. Likelihood to repay measures the history of 
an individual to honor their obligations for low-dollar debts 
including utility payments, rent, etc.

Q.3. Payday loans are advertised as 14-day or 30-day loans. 
Lenders market small-dollar credit loans, such as payday loans, 
as a ``safe,'' ``sensible financial choice,'' and ``the best 
alternative to meet their current needs'' for a ``one-time 
fixed fee.''
    Pew found that borrowers were on average indebted for 144 
days, and CFPB found that they were indebted for 199 days. You 
testified that the Online Lenders Alliance consumer study shows 
that consumers have an average of 70 to 120 days of 
indebtedness per year.
    How do these findings reinforce that the short-term small-
dollar products are not in fact designed to be repaid according 
to their terms?

A.3. These products are designed to meet a specific need. My 
research also finds that the average advance amount has 
steadily increased since 2009 which indicates a shift in 
consumer needs. An installment or line of credit product may be 
more suitable to meet these shifting needs. As I stated in my 
testimony, the payday product fits into a continuum of credit 
products starting with overdrafts and progressing in terms of 
dollar amount, duration, payment scheduling, secured, etc. 
Removing any of these products from the continuum creates a gap 
that the consumer must fill with a less than optimal solution. 
Adding products provides flexibility and choice so that the 
consumer will find solutions that meet their specific 
requirement or circumstance.

Q.4. As a witness at the U.S. House of Representatives 
Subcommittee of Financial Institutions and Consumer Credit 
hearing on access to consumer credit in 2012, you stated that 
divergent States regulations ``deny alternative financial 
services providers the ability to achieve scale thereby 
reducing costs now associated with operating in all 50 
States.''
    What actions would you recommend the Consumer Financial 
Protection Bureau (CFPB) take to provide a level of uniformity 
and Federal oversight of these products, which would in turn 
allow industry to scale products nationwide and reduce costs?

A.4. To my understanding, the CFPB provides consumer protection 
oversight but cannot provide a national platform from which 
standardized products are authorized to exist. I believe that 
Congress must authorize a national platform.
    In terms of establishing national guidelines, the CFPB 
could be invaluable in going after nonlicensed, off-shore 
entities that do not conform to any State or Federal statutes.
    I believe that a national usury cap of 36 percent would 
eliminate credit to millions of consumers who have credit 
scores under 550.

Q.5. The most recent report released by the CFPB shows that 58 
percent of borrowers who take out payday loans on a monthly 
basis are recipients of some kind of benefits--Social Security, 
SSDI, unemployment--or retirement income. The white paper the 
CFPB released last year found that 22 percent of all borrowers 
are on some form of public assistance or relying on retirement 
income.
    Payday is usually advertised as a short-term stopgap to 
fill a consumer's financial needs until the borrower receives 
some new source of income. This is not the case for borrowers 
on a fixed income from Government assistance or in retirement.
    How safe are these products for individuals living on fixed 
incomes?

A.5. If indeed, there is a timing gap to pay an expense, then 
the short-term advance product is appropriate.
    If the premise is that benefits recipients have or will 
have no other source of income in the future, then that would 
say we have a group of citizens who have a permanent reliance 
on benefits. I would have to disagree in that the median age of 
payday loan users is 39 and that Social Security recipients may 
only represent a small fraction of users. Additionally, Social 
Security recipients may earn other income with no limitation 
past the age of 66. Also, unemployment benefits presuppose that 
the consumer will one day be employed again. Remember, these 
loans are a stop gap measure and most users are only in the 
product for approximately 2 years.
    I do not believe that any agency can look into the needs of 
individuals and State that certain products are inappropriate. 
That said, there must be a variety of products available to 
meet individual needs as ``one size does NOT fit all!''

Q.6. Should we be concerned that Government benefits payments 
are going to companies that may be taking advantage of 
borrowers?

A.6. Actually, many of these benefits are paid by the taxpayers 
in terms of unemployment taxes and contributions throughout 
their lifetimes toward social security. I do not believe that 
the Government has a role in telling people how to spend income 
that they have paid for throughout their lives.

Q.7. Payday loan contracts are considered simple in comparison 
to the terms associated with other consumer credit products, 
such as mortgages, credit cards, and other alternative small-
dollar loans like auto-title and installment loans. However, it 
is clear that borrowers have trouble understanding and 
assessing their ability to repay since consumers who use these 
products are in continuous debt.
    Can you explain why it is common for borrowers to 
inaccurately predict their ability to repay in full the loan 
and their likelihood for taking out subsequent loans?

A.7. No, I have not undertaken a behavioral study on this 
subject.

Q.8. What type of disclosures would be most useful?

A.8. I am unsure if the disclosure can be any clearer. If an 
expanded disclosure is inevitable, then a sample of the average 
loan usage and costs incurred of the loan company's customer 
base may prove useful.

Q.9. How would disclosing APRs help borrower assess the actual 
cost of the loan?

A.9. I have never been a proponent on APR as a useful metric 
for loans less than 1 year in duration. It is the same 
reasoning that overdrafts do not disclose APR's. The fee for a 
short-term advance is the most easily understood metric a 
borrower can have. Consider the APR for a $100,000, 30-year 
mortgage, while the APR may state 5 percent, the cost of 
borrowing for the 30-year term is close to the original 
principal amount. Which is more misleading, $45 for a $300 
advance for 2 weeks with the APR of 320 percent or $93,256 for 
a $100,000 mortgage with a 5 percent APR?
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
                     FROM G. MICHAEL FLORES

Q.1. Do you think most unbanked or underbanked Americans are 
capable of handling their own finances, or do you feel that 
Government needs to step in and ``protect them from 
themselves'' by such actions as credit rationing or denying 
them certain credit products?

A.1. I believe that there should be sufficient choices for the 
consumer. Most of these consumers are very capable money 
managers in that they must constantly make choices of how to 
spend their scarce resources.

Q.2. Some argue that States should not be rationing credit 
because in some cases consumers act irresponsibly and get 
deeply in debt. Do you agree, or do you support Government 
stepping in and rationing credit? Some also argue that loan 
prices should be set by the free market and should not be 
subsidized by the Government. What do you think about this 
issue? Should unbanked and underbanked consumers who pose 
higher credit risks have their loans subsidized or be given 
some type of governmental support, or should rates be set 
through the free market?

A.2. In any population, there are a small percentage of 
consumers who account for the majority of volume. The Pareto 
Principle is a decision-making technique that statistically 
separates a limited number of input factors as having the 
greatest impact on an outcome, either desirable or undesirable. 
Pareto analysis is based on the idea that 80 percent of a 
project's benefit can be achieved by doing 20 percent of the 
work, or conversely, 80 percent of problems are traced to 20 
percent of the causes.
    Regardless of the amount of credit that may be authorized 
or restricted for a consumer, there will still be the Paretian 
long tail distribution.
    The market is the best arbiter in that most artificial 
factors limiting the market will have unintended consequences.
    Government subsidies are not the ultimate solution, the 
answer is a robust economy with dynamic job creation and upward 
mobility for consumers.

Q.3. As you undoubtedly know, the Post Office Inspector 
General's Office has recently proposed that the Post Office be 
allowed and encouraged to begin offering small loans and other 
alternative financial services products through partnerships 
with banks and credit unions. Their report claims, for example, 
that the Post Office could offer a $375 loan repayable over 5 
to 6 months at a rate of 28 percent APR that would generate a 
profit of $48 for the Post Office (and its banking partners). 
Do you find the analysis persuasive?

A.3. This is very dangerous territory for bank in that the Post 
Office becomes another vendor and must be managed accordingly. 
This is an example of ``rent-a-charter.'' This could create 
credit and reputational risk for the bank. Also, there has not 
been a successful loan model for small dollar loans that can be 
profitable at 28 percent. For the past 25 years, I have advised 
banks that they cannot make a profitable loan under $5,000 
given their funding, operating, credit administration, 
compliance and credit loss cost structures. That is why banks 
used credit cards, overdrafts and home equity loans for 
consumer loans.
    Consider the funding costs of the loans the bank would 
carry on their books. Then one must consider the operating 
costs including credit administration and compliance the loss 
ratio of these loan is approximately 15 percent. If one looks 
at the following Federal Reserve data for consumer loan 
delinquencies (see http://www.federalreserve.gov/releases/
chargeoff/delallnsa.htm), it is difficult to imagine the 
regulatory not having severe heartburn over a type of credit 
that exhibits a delinquency and charge-off rate greater than 5 
times the banking industry's average: 




Q.4. The Internet has revolutionized Americans' buying habits 
and greatly increased their product choices. Consumers today, 
regardless of where they are located, can obtain essentially 
whatever commercial product they need when it is not available 
locally by going online, getting the best available price and 
having it delivered to their door. Should consumers in every 
State have the same ability to get well-regulated small loans 
and other financial services through the Internet if such 
products are not otherwise available locally?

A.4. Yes, absolutely.

Q.5. Michael Flores' recent study, Online Short-Term Lending, 
points out that the primary alternatives to payday loans are 
often significantly more costly than payday loans. Given that 
finding, would underserved consumers who now rely on 
potentially less costly payday loans be helped or harmed if 
additional States or the CFPB prohibited or severely restricted 
access to these loans? If credit products like payday loans or 
banks' deposit advances are eliminated, what happens to the 
demand for such products?

A.5. My analysis indicates that the $5 million loss of deposit 
advance products will cost consumer significantly more because 
their options are limited to mush more expensive overdrafts and 
slightly more expensive payday loans (if the consumer is in a 
State that allows these loans).
    The consumer is ultimately hurt when credit options are 
limited.
    If most legal credit options are eliminated and demand for 
credit is not assuaged, then consumers will be forced into 
unlicensed or illegal options.

Q.6. In States with arbitrary rate caps not set by the market, 
are consumers who pose significantly higher credit risks really 
able to get the credit they need?

A.6. It is very difficult for these consumers to access credit 
from licensed and legal sources.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR MORAN
                     FROM G. MICHAEL FLORES

Q.1. Many have criticized what they claim is a lack of price 
competition in the current marketplace for small consumer 
loans. Do you believe that the current patchwork of 
proscriptive State laws is limiting competition, preventing 
lenders from achieving otherwise available economies of scale 
or preventing innovative products from reaching a wider 
marketplace? What can Congress do to help make innovative 
products like Ms. Klein's company is offering in a limited 
number of States accessible for all consumers?

A.1. In a more open market with consistent rules from coast to 
coast, consumers will benefit from price competition from a 
variety of companies wishing to compete for their business.
    I believe a national operating platform that is proposed in 
H.R. 1566, is a viable approach and should be considered by the 
Senate.

Q.2. Given the diversity of State lending laws, is it realistic 
to think that more affordable, better suited, yet commercially 
viable short term installment loans that fit with today's 
consumer mobility and technology trends can be offered without 
some type of Congressional action?

A.2. No, there must be a national platform to allow a rollout 
of products which costs can be spread across all markets.

Q.3. You mentioned that a House bill, H.R. 1566, is the best 
approach suggested so far for meeting consumers' credit needs. 
Can you explain why you believe this bill can provide a real 
solution to the credit access problems faced by millions of 
American families?

A.3. This bill will provide an operating platform to allow 
companies to operate and compete for a consumer's business. 
Operating in a 50 State environment will allow companies to 
achieve economies of scale in order to offer price competitive 
products. The more companies who compete will also push 
innovation and lower process, to the ultimate benefit of the 
consumer.

Q.4. When issuing rules implementing the Dodd-Frank Act, the 
OCC made the following very clear and compelling comment 
regarding the importance of uniform national lending standard 
for national banks:
    ``Throughout our history, uniform national standards have 
proved to be a powerful engine for prosperity and growth. 
National standards for national banks have been very much a 
part of this history, benefiting individuals, business and the 
national economy. In the 21st Century, the Internet and the 
advent of technological innovations in the creation and 
delivery of financial products and services has accentuated the 
geographic seamlessness of financial services markets, 
highlighting the importance of uniform standards that attach 
based on the product or service being provided, applying 
wherever and however the product or service is provided. 
However, the premise that Federally chartered institutions 
would be subject to standards set at the Federal, rather than 
State-by-State level, does not and should never mean that those 
institutions are subject to lax standards . . . [Any] concerns 
that have been expressed that Federal consumer protection rules 
were not sufficiently robust should be addressed by the CFPB's 
authority and mandate to write strong Federal consumer 
protection standards, and its research-based and consumer-
tested rulemaking processes envisioned under the Dodd-Frank 
Act.''
    Isn't H.R. 1566, the House bill you mentioned that would 
create a Federal charter for qualified online nonbank lenders, 
aimed at giving these lenders the same operating efficiencies 
as national banks, letting them to innovate by giving them the 
ability to lend nationwide, subject to strong Federal 
regulation, ensuring that consumers everywhere can benefit from 
better, more innovative financial products, which necessitates 
uniform national standards as the OCC pointed out?

A.4. Yes as I mentioned in the preceding answer.

Q.5. Your testimony notes that ``Innovative companies, many of 
them operating exclusively on the Internet, are trying to 
design flexible products to meet'' consumer credit demands, but 
that many in industry tell you that ``real innovation is 
limited'' because of diverse State lending laws. How do you see 
these State laws affecting consumers as they seek to obtain 
innovative, more affordable small loans and other financial 
products through the Internet? Would Federal legislation open 
up credit access?

A.5. The Internet is the ultimate (to date) disruptive 
technology. State laws and State barriers to entry worked when 
we all lived in an analogue world where consumer were limited 
to products and services offered by businesses who had physical 
operations in the market where the consumer lived. Some of 
these State laws were designed to protect local businesses from 
out-of-State competition. Businesses today must adapt to 
today's realities and cannot be protected from companies who 
may be able to provide a better product or service at less 
expense.
    While I understand the ``States' rights'' argument about 
overreach by the Federal Government, it is a fait accompli that 
consumers have access to products and services from all over 
the globe.
    I believe Federal legislation would, indeed, open up access 
to credit and allow the development of a variety of products 
designed to meet unique needs of consumers.
    One last point I would like to make. During the 
questioning, Senator Merkely asked about the Oregon law that 
prohibits payday loans. While the Oregon law does have a 36 
percent rate cap, it does allow for a $10 per $100 origination 
fee (up to $30) for each new loan in addition to the 36 percent 
interest. This is a hybrid payday product and companies can 
make this loan because of the origination fee. If consumers 
find this product useful for their circumstances, a national 
charter would not inhibit companies from offering this loan.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN
                        FROM NICK BOURKE

Q.1. The FDIC and consumer groups have advocated for small-
dollar products that have four features:

  a.  reasonable APRs;

  b.  repayment period longer than 90 days;

  c.  ability to repay principal;

  d.  and the borrower demonstrates an ability to repay the 
        loan in full.

    Some lenders have responded to criticism of the payday 
product by moving toward installment loans. You stated in your 
testimony that installment loans are an encouraging market 
solution for consumers. As an example of an installment 
product, Enova offers a 7 months and 13 months installment 
product in New Mexico with APRs of 389 percent and 393 percent, 
respectively.
    As industry moves toward lengthening repayment terms, is it 
possible to address the issue of affordability of small-dollar 
credit products without addressing all four of the features 
mentioned? Please explain why or why not.

A.1. In the vast majority of cases, lump-sum payday loans will 
not meet any rational ability-to-repay test, requiring lenders 
instead to provide installment loans that borrowers can pay off 
over time. But converting a payday loan to an installment loan 
will not by itself ensure that the payments are affordable. 
More rigorous ability to repay standards are required, as well 
as other safeguards. Pew's research has demonstrated that most 
payday loan borrowers cannot afford to spend more than 5 
percent of their periodic pretax income on loan payments (for 
example, a typical borrower making $2,500 per month could not 
afford loan payments of greater than $125 per month). Loans 
that meet this 5 percent benchmark may merit streamlined 
regulatory underwriting requirements if policy makers wish to 
promote access to credit for those with damaged credit 
histories.
    However, any loan that requires periodic payments in 
amounts that exceed 5 percent of a borrower's gross periodic 
paycheck must be rigorously underwritten to ensure the borrower 
can repay the loan and all other expenses without reborrowing. 
These requirements generally will result in installment loans, 
though they do not preclude the possibility of loans that could 
last shorter than 90 days.
    Pew does not have a specific recommendation regarding the 
price of small-dollar loans that are marketed to those with 
damaged credit histories. However, setting maximum allowable 
prices is warranted in markets, such as this one, where there 
is evidence that competition does not put downward pressure on 
prices or where consumers are inherently vulnerable. Research 
shows that lenders generally do not compete on price in these 
markets serving those with poor credit, which is why almost 
every State has laws that set maximum allowable rates on small-
dollar loans. Without regulations, prices reach levels that are 
highly disproportional to lender cost, or far higher than 
necessary to ensure access to credit. Colorado's payday loan 
law shows it is possible to ensure widespread access to loans 
of $500 or less for people with poor credit histories, at 
prices far lower than those charged for conventional payday 
loans. It is also possible that such credit could be available 
at rates lower than the average APR of 129 percent in Colorado. 
In States that have permitted higher interest rates than this, 
storefronts have proliferated, with no obvious additional 
benefit to consumers (for more information, see Pew's recently 
released fact sheet, How State Rate Limits Affect Payday Loan 
Prices).
    States may reasonably choose to set maximum annualized 
interest rates of 36 percent or less if they do not want payday 
lenders to operate. States may also reasonably choose to allow 
interest rates higher than 36 percent if they do want payday 
lenders to operate. Meanwhile, the Consumer Financial 
Protection Bureau must take action to ensure that all small-
dollar loans are safe and transparent. The CFPB should enact a 
strong ability to repay standard, and require several 
commonsense safeguards for small-dollar loans. These safeguards 
include requirements for substantially equal payments that 
amortize smoothly over time, and for spreading fees and costs 
evenly over the life of the loan to reduce the risk of loan 
flipping, i.e., lender-driven refinancing that creates long-
term indebtedness and drives up cost. More discussion is 
provided in our response to Question 2 below.
    For more information: Please see Pew's Policy Solutions 
report (2013). Section 3 (starting at page 26) discusses 
factors for ensuring affordability in installment loan markets. 
Section 4 (starting at page 33) discusses important 
considerations for payday loan reform, including a number of 
common problems found in installment loan markets in addition 
to the ability to repay problem. Pew's detailed policy 
recommendations are found on pages 44-47.
    For more on the lack of price competition in payday loan 
markets, see How State Rate Limits Affect Payday Loan Prices 
(The Pew Charitable Trusts, 2014).
    A collection of Pew's research on small-dollar lending, 
including summaries and interactive displays, is available at 
www.pewtrusts.org/small-loans.

Q.2. You stated in your testimony that ``lenders' reliance on 
long-term borrowing behavior indicates a fundamental flaw in 
the business model that can only be addressed by requiring 
loans to be structured differently (mainly, as installment 
loans).''
    What research has Pew conducted to determine if similar 
roll-over behaviors are expected from an installment product?

A.2. Pew's Payday Lending in America series of reports has 
demonstrated the significant gap that exists between how payday 
loans are packaged and marketed (i.e., as short-term, fixed-fee 
products for temporary needs) and how most borrowers experience 
them (the average borrower is dealing with an endemic financial 
shortfall, is in payday loan debt for 5 months, and pays $520 
in finance charges, nearly ten times the advertised price of a 
typical payday loan). The conventional payday loan business 
model relies on this gap for its profitability. Analysis of 
State regulatory data shows that nearly all lender revenue 
comes from repeat borrowers: Lenders make 97 percent of their 
revenue from borrowers who use three or more loans per year, 
and 63 percent of revenue from those using 12 or more loans per 
year. Consecutive usage is the norm. According to the CFPB, 80 
percent of loans originate within 14 days of a previous loan, 
and half of all loans occur within a continuous sequence often 
or more loans.
    Similar problems can occur in installment loan markets. For 
example, installment loans with front-loaded or unaffordable 
payments can lead to refinancing and nontransparent cost 
structures, as described in the following excerpt from Pew's 
Policy Solutions report (2013), at pages 33-34 (citations are 
not included below but can be found in the original report):

        When lenders can earn nonrefundable fees for 
        originating loans, or when they can front-load interest 
        during the beginning of the repayment period, they have 
        incentive to encourage customers to refinance, or flip, 
        loans. Flip is used to describe reborrowing that a 
        lender encourages, whereas renew and reborrow have been 
        used in this series to describe additional borrowing 
        caused by an inability to cover expenses after repaying 
        a loan.

        Loan refinancing can give borrowers access to 
        additional credit when they want it. Take, for example, 
        a borrower in the third month of a 6-month installment 
        loan. The borrower might be eligible to refinance the 
        loan because she has paid down some of the principal. 
        Refinancing would provide her with cash in hand. But it 
        would also extend her indebtedness by pushing back the 
        loan's payoff date.

        If lenders can use refinancing to earn more fees 
        immediately, or if they can calculate interest to earn 
        a disproportionately high share of revenue during the 
        loan's first few months, they have an incentive to flip 
        loans. This flipping places borrowers at risk of 
        financial harm because of the new fees, interest 
        payments, and additional months of debt. Excessive 
        refinancing also can mask delinquencies, because if 
        borrowers are unable to afford loan payments, lenders 
        can effectively let them skip a payment by agreeing to 
        extend the duration of their loan, a process known as 
        re-aging loans.

        There are two lender incentives to encourage 
        refinancing that can cause borrowers financial harm.

        [1] When small loans carry an origination fee, lenders 
        can earn a substantial portion of revenue at the outset 
        of the loan, creating a strong incentive to encourage 
        borrowers to refinance or pay it off and reborrow 
        quickly so the lender earns another origination fee. As 
        a result, refinancing is common in small-loan markets 
        that allow an origination fee to be earned in full when 
        the loan is made.

        Lenders may rely on origination fees to provide a 
        measure of predictability in their revenue streams in 
        the event that borrowers repay the loans early. Yet 
        since most small-dollar loan borrowers cannot pay the 
        loans off quickly, lenders can rely on their paying 
        interest charges for several months (as in Colorado, 
        where the average borrower carries a loan for more than 
        three months even though money is saved by paying off 
        earlier). And although lenders might legitimately 
        employ such fees as compensation for the cost of 
        opening new loans (as ``origination fee'' suggests), 
        policy makers must be aware of the strong link between 
        origination fees and loan flipping.

        In this market, lenders' desire to supplement interest 
        income by adding origination fees seems minor compared 
        with the significant risk that loan flipping poses to 
        consumers and the marketplace. Accordingly, policy 
        makers should limit the use of origination fees in 
        small-dollar loan markets. Possible approaches include 
        limiting fees to a nominal amount, restricting the 
        number of fees to one per borrower in a year, or, as 
        Colorado lawmakers have done and as Pew recommends, 
        requiring any fees to be spread evenly over the life of 
        the loan, so they would be refunded on a pro rata basis 
        if loans are refinanced or repaid early.

        [2] In some States, lenders are allowed to use 
        accounting methods that overweight the accrual of 
        interest charges during the loan's early months, 
        meaning that initial payments include a relatively high 
        proportion of interest revenue for lenders, and 
        payments in later months have relatively low interest 
        revenue. Such front-loading methods, often known as the 
        ``rule of 78s'' or ``sum of digits,'' incentivize 
        refinancing because lenders earn far more interest 
        income at the outset of the loan than they would using 
        the standard actuarial method of calculating interest 
        used for other financial products, such as mortgages or 
        auto loans.

        When lenders can book much of the interest revenue 
        during the early months of a loan, they have an 
        incentive to flip loans into new ones, so that more of 
        these lucrative early months occur. This can lead to 
        practices that entice borrowers to refinance loans to 
        receive a fresh infusion of cash, despite the costly 
        net impact of front-loaded interest payments. The harm 
        to borrowers who refinance or pay off their loan early 
        is that more interest and less principal are paid than 
        would be paid under a conventional method of 
        calculating interest. Lawmakers sometimes address this 
        problem by requiring lenders to use the standard 
        actuarial method. Pew recommends this approach as well.

        Of course, lenders have a natural incentive to 
        encourage repeat business. Default risk is higher with 
        new borrowers than with existing customers. It also 
        generally costs lenders far more to acquire a new 
        customer than to keep an existing one, giving them an 
        incentive to extend their relationships with customers, 
        as is true with other businesses. If a borrower can pay 
        off a loan and cover other expenses, and then chooses 
        to borrow again, this dynamic might pose no problem. 
        But when a lender maintains a long-term relationship 
        with a borrower by encouraging frequent refinancing, 
        the borrower does not receive the benefits of a 
        nominally closed-end loan. In such cases, a gap between 
        packaging and experience emerges and leads a borrower 
        to spend more and stay in debt longer than the loan's 
        initial terms stated.

        In sum, consumers can be harmed by small-dollar 
        installment loans in the absence of regulations that 
        eliminate lender incentives to flip loans.

Q.3. Lenders offerings small-dollar installment credit products 
claim they can help borrower build a credit history and improve 
credit scores. Enova testified that they have been working to 
foster relationships with the major credit bureaus, and hope to 
help consumers build credit history.
    Can you explain how these products have improved the credit 
scores for individual consumers?

    Conventional payday lenders making lump-sum and installment 
payday loans generally do not report to credit bureaus. Nonbank 
installment lenders generally do report to credit bureaus. 
There has been little research on the credit score trajectory 
of nonbank installment loan customers. In order for customers 
to be successful in using installment loans and improve their 
credit scores, it is crucial that the loan payments are 
affordable and fit within their ability to repay.
    It is worth noting that access to additional credit will 
not lead to better outcomes for some borrowers. Customers who 
turn to high-interest small-dollar loans often have very low 
credit scores because they are already heavily indebted and/or 
struggling to make ends meet. For example, rather than being 
``thin file'' or ``no file'' consumers who are creditworthy but 
lack access to mainstream credit, most payday loan borrowers 
are ``thick file'' consumers who have substantial experience 
with debt. More than half of payday loan borrowers carry credit 
card debt, two in five own homes (many with mortgages), and 
many also hold student loans, auto loans, and other debt. The 
average payday loan applicant has a credit score in the low 
500s, indicating an assessment by credit reporting agencies 
that payday borrowers are already overburdened with debt and/or 
struggling to meet financial obligations. For more information, 
see Pew's Policy Solutions report (2013), at pages 26-27 (the 
section entitled, ``The Limited Benefits of Access to 
Credit'').

Q.4. Payday loans are advertised as 14-day or 30-day loans. As 
Pew stated in the Payday Lending in America series, lenders 
market small-dollar credit loans, such as payday loans, as a 
``safe,'' ``sensible financial choice,'' and ``the best 
alternative to meet their current needs'' for a ``onetime fixed 
fee.''
    You testified that borrowers were on average indebted for 
144 days, and CFPB found that they were indebted for 199 days. 
The Online Lenders Alliance consumer study shows that consumers 
have an average of 70 to 120 days of indebtedness per year.
    Please explain how do these findings reinforce that the 
short-term small-dollar products are not in fact designed to be 
repaid according to their terms?

A.4. These findings demonstrate a large gap between how a 
product is packaged and how it is experienced. As demonstrated 
below, this gap exists because of loan structures that promote 
frequent refinancing and business models that cannot be 
profitable without such frequent refinancing.
    A. Most payday loan borrowers are in long-term financial 
distress, and they turn to payday loans for funds to cover 
regular monthly costs.

    Payday borrowers routinely struggle to pay their 
        bills: 58 percent report having trouble paying regular 
        bills at least half the time, and one-quarter have 
        trouble paying bills every single month.

    69 percent of payday borrowers turned to a payday 
        loan for help paying recurring expenses (such as rent, 
        mortgage, utilities, credit card bills, and so on).

    B. Payday loans are fundamentally unaffordable because they 
take too much of a typical borrower's next paycheck, 
undermining their ability to repay the loan and keep up with 
regular bills.

    A typical payday loan requires a payment of $430 on 
        the borrower's next payday, or 36 percent of a typical 
        borrower's gross (pretax) paycheck.

    Most borrowers can afford to pay no more than 5 
        percent of their pretax paycheck toward a loan while 
        meeting other financial obligations without having to 
        borrow again to make ends meet.

    C. When loan payments exceed borrowers' capacity to repay, 
extended usage is the norm.

    Unaffordable payments lead to consecutive 
        reborrowing: 80 percent of payday loans originate 
        within 14 days of a previous loan.

    The average payday borrower is in debt for 5 months 
        of the year, even though many borrowers sought to avoid 
        ``more debt'' or ``another bill.''

    The average borrower pays $520 in fees per year, 
        far higher than the $55 ``fixed fee'' for the average 
        payday loan.

    D. The payday loan business model requires extended usage 
to be profitable

    Almost all payday revenue comes from repeat 
        borrowers: 97 percent of loans go to those using three 
        or more per year, and 63 percent of loans comes from 
        those who use 12 or more per year.

    The business model is not profitable until the 
        average borrower uses four to five loans per year.

    Payday and other small-dollar loan business models are 
fundamentally reliant on this pattern of unaffordability and 
reborrowing for their profitability--a fact that represents one 
of the most striking failures of this marketplace and one which 
policy makers have too often overlooked. Going forward, 
regulators should monitor the percentage of revenue that payday 
and installment lenders receive from loan refinancing, because 
high rates of refinancing are indicative of poor underwriting 
or other harmful practices.

Q.4. The most recent report released by the CFPB shows that 58 
percent of borrowers who take out payday loans on a monthly 
basis are recipients of some kind of benefits--Social Security, 
SSDI, unemployment--or retirement income. The white paper the 
CFPB released last year found that 22 percent of all borrowers 
are on some form of public assistance or relying on retirement 
income.
    Payday is usually advertised as a short-term stopgap to 
fill a consumer's financial needs until the borrower receives 
some new source of income. This is not the case for borrowers 
on a fixed income from Government assistance or in retirement.
    How safe are these products for individuals living on fixed 
incomes?
    Should we be concerned that Government benefits payments 
are going to companies that may be taking advantage of 
borrowers?

A.4. Pew's research has found that 41 percent of borrowers use 
a cash infusion, like a tax refund or help from family or 
friends, to repay a payday loan. Academic research has found 
that payday loan balances outstanding decline during the early 
months of the year when tax refunds are distributed. An average 
payday loan payment requires 36 percent of an average 
borrower's bi-weekly income. This figure will average 15 to 20 
percent for someone who receives income monthly instead. Pew's 
research indicates that most borrowers can spend no more than 5 
percent of their income on payday loan payments while meeting 
other expenses. Therefore, without a cash infusion, many people 
on fixed incomes have difficulty retiring payday loan debts 
because of the loan's lump-sum payment structure.

Q.5. Payday loan contracts are considered simple in comparison 
to the terms associated with other consumer credit products, 
such as mortgages, credit cards, and other alternative small-
dollar credit like auto-title and installment loans. However, 
it is clear that borrowers have trouble understanding and 
assessing their ability to repay since consumers who use these 
products are in continuous debt.
    Can you explain why it is common for borrowers to 
inaccurately predict their ability to repay in full the loan 
and their likelihood for taking out subsequent loans?
    What type of disclosures would be most useful?
    How would disclosing APRs help borrower assess the actual 
cost of the loan?

A.5. Under a lump-sum loan structure, only a product's 2-week 
cost is clear, but very few loans are made to customers who 
repay them without quickly reborrowing. This gap means that the 
product's stated cost is dramatically different from how much 
the borrower ultimately spends. As an example, when Colorado 
had lump-sum payment loans under its previous law, the stated 
cost represented only 13 percent of the dollars spent by an 
average customer annually. After the law change created a 
transparent installment product, the stated cost represented 87 
percent of the dollars spent by an average customer annually.
    Excerpts from How Borrowers Choose and Repay Payday Loans 
and Policy Solutions follow:

        More than three-quarters of borrowers in Pew's survey 
        stated that they rely on the payday lender to provide 
        accurate information, but information is provided only 
        about a two week product, even though borrowers end up 
        indebted for an average of 5 months. Because the loans 
        do not amortize, paying just the fee--the salient price 
        that borrowers are instructed to pay if they cannot 
        afford full repayment--does not reduce the amount owed, 
        leaving them no closer to eliminating the debt. 
        Therefore relying on the lender for accurate 
        information makes the ultimate cost and duration of the 
        debt extremely difficult to predict.

        Financial education and disclosures are important tools 
        for helping people decide whether a product that many 
        successfully use is appropriate for them. Public 
        explanations and advice on the terms and conditions for 
        a home mortgage, student loan, auto loan, or credit 
        card are commonplace. Many people use these products 
        successfully and as advertised.

        Some do not, and financial education and disclosures 
        can help consumers avoid the downsides of these 
        products. In contrast, payday loans are not used 
        successfully on a short-term basis by many people, and 
        if they were, the industry would not be profitable.

        Neither disclosures nor financial education can solve 
        the problems caused by lump-sum repayment payday loans 
        because their structure hides the most common outcome--
        repeated reborrowing of the original loan.

        Although financial education and disclosure cannot 
        solve the problems with lump-sum payday loans, they 
        will be an important component in a properly 
        functioning marketplace for installment loans. When 
        designed to avoid the pitfalls discussed earlier in 
        this section, such loans can be used successfully by 
        many people, but they will not be appropriate for some. 
        In that case, financial education and clear disclosures 
        can help people decide whether they should borrow and 
        if so, whether such products are a good choice for them 
        and how to use those products successfully.

        One method for measuring the value of financial 
        education and disclosures will be whether consumers 
        comparison-shop and seek out lower prices for loans.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
                        FROM NICK BOURKE

Q.1. Do you think most unbanked or underbanked Americans are 
capable of handling their own finances, or do you feel that 
Government needs to step in and ``protect them from 
themselves'' by such actions as credit rationing or denying 
them certain credit products?

A.1. A key policy goal should be to ensure a safe and 
competitive marketplace, in which all potential borrowers of 
small-dollar loans can choose products based on transparent 
information that allows them to predict costs accurately. 
Unfortunately, there is extensive evidence that the small-
dollar loan market fails this test.
    For example, consider the large gap that exists between how 
a payday loan is advertised or packaged and how it is 
experienced. As demonstrated below, this gap exists largely 
because of loan structures that encourage frequent refinancing 
and business models that cannot be profitable without such 
frequent refinancing.
    A. Most payday loan borrowers are in long-term financial 
distress, and they turn to payday loans for funds to cover 
regular monthly costs.

    Payday borrowers routinely struggle to pay their 
        bills: 58 percent report having trouble paying regular 
        bills at least half the time, and one-quarter have 
        trouble paying bills every single month.

    69 percent of payday borrowers turned to a payday 
        loan for help paying recurring expenses (such as rent, 
        mortgage, utilities, credit card bills, and so on).

    B. Payday loans are fundamentally unaffordable because they 
take too much of a typical borrower's next paycheck, 
undermining their ability to repay the loan and keep up with 
regular bills.

    A typical payday loan requires a payment of $430 on 
        the borrower's next payday, or 36 percent of a typical 
        borrower's gross (pretax) paycheck.

    Most borrowers can afford to pay no more than 5 
        percent of their pretax paycheck toward a loan while 
        meeting other financial obligations without having to 
        borrow again to make ends meet.

    C. When loan payments exceed borrowers' capacity to repay, 
extended usage is the norm.

    Unaffordable payments lead to consecutive 
        reborrowing: 80 percent of payday loans originate 
        within 14 days of a previous loan.

    The average payday borrower is in debt for 5 months 
        of the year, even though many borrowers sought to avoid 
        ``more debt'' or ``another bill.''

    The average borrower pays $520 in fees per year, 
        far higher than the $55 ``fixed fee'' for the average 
        payday loan.

    D. The payday loan business model requires extended usage 
to be profitable

    Almost all payday revenue comes from repeat 
        borrowers: 97 percent of loans go to those using three 
        or more per year, and 63 percent of loans comes from 
        those who use 12 or more per year.

    The business model is not profitable until the 
        average borrower uses four to five loans per year.

    Payday and other small-dollar loan business models are 
fundamentally reliant on this pattern of unaffordability and 
reborrowing for their profitability--a fact that represents one 
of the most striking failures of this marketplace and one which 
policy makers have too often overlooked.
    Fifteen States do not have payday lending stores, usually 
because they have declined to exempt payday lenders from the 
State's usury laws. Existing research is inconclusive as to 
whether individuals fare better with or without access to high-
interest credit, but the research is clear that where high-
interest credit is available, borrowers who use loans with 
affordable payments fare better than those who use loans with 
lump-sum payments.
    Some States have decided to allow high-interest credit, but 
with limits on how many loans, or how much money, a customer 
may borrow at a time or in a year. In Colorado, officials 
recognized that payday loans were working poorly, largely 
because their payments were unaffordable. The 2010 reform they 
passed, requiring at least 6 months to repay in affordable 
installments, instead of a 2-week balloon payment, has 
succeeded as a result. An excerpt from Pew's Policy Solutions 
report follows, describing why Colorado officials elected to 
fix the failed balloon-payment payday loan, rather than leaving 
it intact and attempting to mitigate its harm through limiting 
its usage:

        Some States with loan-rationing strategies have 
        decreased the volume of borrowing, and have saved 
        consumers money and protected them against some of the 
        financial harm from the long-term use of payday loans. 
        But such measures do not address the loans' fundamental 
        unaffordability. Furthermore, rationing amounts to a 
        tacit admission that the lump-sum repayment payday loan 
        is fundamentally broken or harmful. Rationing requires 
        a database to track and limit loan usage, yet State-
        administered databases are not typical for other 
        financial products. Instead, credit decisions are 
        generally left to borrowers and lenders, and State 
        governments rarely limit usage or control borrowing 
        behavior.

        Colorado legislators explicitly rejected loan 
        rationing, electing instead to address the fundamental 
        unaffordability of the loan rather than preserving the 
        product's unaffordable structure and then trying to 
        mitigate its harm through limiting the number of loans 
        or renewals. One elected official explained the 
        Government's intentions in replacing the old law: 
        ``They get a loan, two weeks they have to pay $575 
        back. Well, they didn't have the money to begin with. 
        What changed in two weeks to allow them to deal with 
        that? Nothing. So then they were caught in a cycle. So 
        making it more affordable and allowing them to pay it 
        over 6 months . . . was key to being able to solve the 
        cycle of debt.''

        An additional reason for rejecting a loan-rationing 
        approach was a dislike of databases to track loan 
        usage. One elected official said: ``People in Colorado 
        don't like those things [databases] . . . . To me, 
        that's like, `the Government wants to know what?' '' 
        Another elected official said: ``I'm opposed to that 
        kind of micromanagement from the Government.'' A 
        consumer advocate agreed that opposition to a database 
        was widespread: ``There's absolutely no support in our 
        legislature for a database from either side. In fact, 
        we had a database built into the bill in '08 initially, 
        and it caught as much flak from people on the left as 
        it did on the right. It was an absolute nonstarter, 
        which was also the problem with the loan restriction 
        bill that caused a great difficulty, and we had to have 
        a database for that in order to make it work.''

        Officials in Colorado decided to focus on fixing the 
        problems that existed with the product, rather than 
        leaving it intact and placing behavioral constraints on 
        the borrower.

Q.2. Some argue that States should not be rationing credit 
because in some cases consumers act irresponsibly and get 
deeply in debt. Do you agree, or do you support Government 
stepping in and rationing credit? Some also argue that loan 
prices should be set by the free market and should not be 
subsidized by the Government. What do you think about this 
issue? Should unbanked and underbanked consumers who pose 
higher credit risks have their loans subsidized or be given 
some type of Governmental support, or should rates be set 
through the free market?

A.2. There are many financial products that a minority of 
customers use irresponsibly or poorly, while most use them 
successfully, as designed. With products like these, financial 
education and disclosures are good tools to preserve the 
benefits of the products for most customers, but help the 
minority avoid harm. In contrast, payday loans are used as 
designed by few customers, and the product's balloon-payment 
structure predictably leads to a situation where most borrowers 
fail. Approximately 80 percent of loans are made within 2 weeks 
of a previous loan's due date, indicating that customers do not 
have the ability to repay the loans without quickly 
reborrowing.
    Unbanked consumers are generally ineligible for payday 
loans, because they cannot provide access to their checking 
account via postdated check or ACH as collateral for the loan. 
While payday loan borrowers have poor credit scores, an excerpt 
from Policy Solutions follows, explaining that the driver of 
high payday loan prices is not credit loss (borrower risk):

        Payday loan interest rates are not high simply because 
        lenders must compensate for high losses; they are high 
        primarily because of overhead. Although payday 
        borrowers generally have a damaged credit history, two-
        thirds of revenue covers storefront and corporate 
        overhead and only one-sixth covers losses. This dynamic 
        helps explain why lenders do not assess ability to 
        repay: Underwriting reduces losses, which are already 
        low, but can increase costs, which are already high.

    On the question of pricing, the same lenders charge similar 
borrowers very different prices for the same loans, based on 
State interest rate limits. In some States, lenders charge more 
than double for the same loan what they charge in other States. 
In States that have set lower-than-average limits on payday 
loan prices (but still above 36 percent APR), access to credit 
has not been significantly constrained. Another excerpt from 
Policy Solutions follows:

        Nearly all States have set maximum interest rate limits 
        for some types of loans. All 13 original colonies did 
        so. Today, 46 States and the District of Columbia set 
        limits on the interest rates that may be charged on at 
        least one type of small-dollar loan. Even in the 35 
        States that allow high-interest, lump-sum payday loans, 
        28 limit the permissible charges. In other words, 
        small-dollar loan markets normally operate with State-
        mandated price limitations. Previous research finds 
        that payday borrowers do not focus primarily on price 
        when taking out a loan, but rather on convenience and 
        speed. Further, demand for payday loans is not 
        sensitive to price. The United Kingdom's Office of Fair 
        Trading conducted a review of the payday lending 
        industry in that country, which also uses lump-sum 
        repayments. Among its findings: ``A significant 
        proportion of payday borrowers have poor credit 
        histories, limited access to other forms of credit and/
        or a pressing need of money at the point of taking out 
        a loan. As such they may be focused on the speed and 
        convenience of the loan rather than its price. Price 
        insensitivity among consumers is likely to weaken price 
        competition, thereby enabling lenders to raise their 
        prices without losing business.'' In such 
        circumstances, setting maximum allowable rates can 
        ensure that borrower costs resemble those in a 
        marketplace with price competition.

        Payday loan prices vary between States but rarely 
        within States. Prices are determined by individual 
        State laws, and large companies offer the same loan at 
        vastly different prices in different States. In States 
        where conventional payday loans are offered, lenders 
        generally do not compete on price; they tend to cluster 
        prices at the maximum allowed, and then compete on 
        customer service and location. As shown in the 
        accompanying exhibit, a similar pattern emerges for 
        payday lenders that also make installment loans. These 
        lenders charge less in Colorado and Illinois, which 
        require lower interest rates on payday installment 
        loans, and more in the States that allow higher prices. 
        There is little evidence of firms lowering prices to 
        compete for customers--the expected result in a well-
        functioning marketplace as described in classical 
        economic theory.

    For more on the lack of price competition in payday loan 
markets, see How State Rate Limits Affect Payday Loan Prices 
(The Pew Charitable Trusts, 2014).

Q.3. As you undoubtedly know, the Post Office Inspector 
General's Office has recently proposed that the Post Office be 
allowed and encouraged to begin offering small loans and other 
alternative financial services products through partnerships 
with banks and credit unions. Their report claims, for example, 
that the Post Office could offer a $375 loan repayable over 5 
to 6 months at a rate of 28 percent APR that would generate a 
profit of $48 for the Post Office (and its banking partners). 
Do you find the analysis persuasive?

A.3. In the example cited, a customer would borrow $375 and 
repay approximately $423 ($48 in interest and fees) over 5.5 
months. The Inspector General's report used the example of a 25 
percent annualized interest rate plus a $25 loan fee. The 
resulting APR would be approximately 46 percent. Such a loan 
would produce $48 in revenue, but the report did not estimate 
the loan's profitability. Insufficient information about losses 
and overhead is available to project the profitability of the 
hypothetical loan described. Small-dollar loans are available 
from some credit unions, a few nonbank alternative lenders, and 
a few banks at rates similar to the one discussed here. Nonbank 
lenders have lowered prices substantially when States have 
reduced allowable prices (without corresponding declines in 
access to credit), though no conventional storefront lenders 
offer loans at prices approximating 46 percent APR.

Q.4. The Internet has revolutionized Americans' buying habits 
and greatly increased their product choices. Consumers today, 
regardless of where they are located, can obtain essentially 
whatever commercial product they need when it is not available 
locally by going online, getting the best available price and 
having it delivered to their door. Should consumers in every 
State have the same ability to get well-regulated small loans 
and other financial services through the Internet if such 
products are not otherwise available locally?

A.4. Federal standards are appropriate to ensure a basic floor 
for product safety. Pew has outlined detailed policy 
recommendations in order to make payday loans safer. But a 
Federal charter for payday lenders would undermine the 
authorities over interest rates and consumer protections that 
traditionally have resided with States.

Q.5. Michael Flores' recent study, Online Short-Term Lending, 
points out that the primary alternatives to payday loans are 
often significantly more costly than payday loans. Given that 
finding, would underserved consumers who now rely on 
potentially less costly payday loans be helped or banned if 
additional States or the CFPB prohibited or severely restricted 
access to these loans? If credit products like payday loans or 
banks' deposit advances are eliminated, what happens to the 
demand for such products?
    In thinking about consumers' costs, it is crucial to know 
whether one product is a substitute for another, or whether it 
is instead one used in addition to another. It is not clear 
that payday loans on net help customers spend less on other 
products, like overdraft. Demand for credit is also not fixed, 
but is instead shaped by convenience, advertising, and 
perceptions of providers. An excerpt on overdraft substitution 
from How Borrowers Choose and Repay Payday Loans follows:

        Payday loans are sometimes promoted as a cost-effective 
        alternative to checking account overdrafts. (A major 
        storefront and online payday lender encourages 
        borrowers to ``use payday loans to stop a bank 
        overdraft or NSF fee,'' and a prominent online payday 
        loan Web site states, ``avoid costly overdraft fees and 
        charges!'') However, more than half of payday loan 
        borrowers report having overdrafted their accounts in 
        the past year, and 27 percent report that a payday 
        lender making a withdrawal from their bank account 
        caused an overdraft. Moreover, Pew's prior research has 
        shown that the vast majority of those who overdraw 
        their accounts do so by mistake, not by intention. 
        Although people choose payday loans in order to avoid 
        overdrafts, many end up paying payday loan fees and 
        overdraft fees as well.
        Although it is unclear how much payday borrowing may 
        reduce or increase the likelihood of checking account 
        overdrafts, Pew's research shows that payday loans do 
        not eliminate overdraft risk. Prior research has found 
        that some payday loan borrowers are explicitly choosing 
        to use the loans to avoid overdrafts and bounced 
        checks, but Pew's survey research demonstrates that 
        borrowers are incurring overdraft fees anyway.

    An excerpt on credit demand from Pew's comment letter to 
the OCC and FDIC follows:

        Another important area to consider after a policy shift 
        occurs is whether customers who used a product that has 
        been altered will substitute an inferior product. The 
        CFPB's recent white paper examined the small number of 
        banks that offer deposit advance products. At those 
        banks, 15 percent of all eligible checking account 
        customers are utilizing deposit advances. Other data 
        indicate that only four percent of adults use 
        storefront payday loans, and even fewer use online 
        payday loans. In other words, where banks are offering 
        payday-like loans, they are experiencing very high 
        levels of usage compared to payday loan usage in the 
        general population. Conversely, where banks do not 
        offer such loans, there is no evidence of higher usage 
        of payday loan stores. Thus, it should not be assumed 
        that bank deposit advance borrowers will shift to 
        storefront or online payday loans.

        Pew's research also shows that people are no more 
        likely to seek cash advances online when storefronts 
        are not unavailable in their communities. The rate of 
        online borrowing in States that essentially prohibit 
        storefront payday lending is identical to the rate of 
        online borrowing in States where payday loans are 
        available from stores. These figures have important 
        implications as we think about substitution as compared 
        with demand generation in the broader small-dollar 
        credit market.

        Pew's research with storefront and online payday 
        borrowers indicates that people who find themselves 
        unable to pay bills are often not choosing between 
        formal credit products. Instead, they choose between a 
        variety of options, with a majority saying they would 
        cut back on expenses, delay paying bills, borrow from 
        family or friends, or sell or pawn possessions if they 
        did not have access to payday loans. Thus it is 
        important to place bank deposit advance loans in the 
        larger context of borrowers' decision making, 
        recognizing that they are choosing between many 
        options, and will not necessarily be motivated to seek 
        the services of conventional payday lenders because of 
        a lack of payday loan options at banks.

        Because of a deposit advance's unaffordability, it is 
        unclear whether it functions as a substitute for other 
        credit products or overdrafts, or whether deposit 
        advance borrowers simply pay more fees as they use both 
        products. The CFPB report's finding that 65 percent of 
        deposit advance customers overdraft too is instructive. 
        While it is still unclear whether deposit advances on 
        net increase or decrease overdrafts, it is clear that 
        they do not eliminate overdraft risk, and most 
        borrowers pay fees for both.

Q.6. Your report says (p. 46) that ``PEW does not recommend law 
changes in the 15 States that do not have payday lending, 
because such a change may not benefit consumers.'' On the other 
hand such a change may benefit consumers if they need a credit 
product that State law currently prohibits. Do you think 
consumers are better off with a properly structured and 
regulated loan at a market based rate than to have no loan 
available due to an prohibitive cap?

A.6. Lump-sum payday loans are not properly structured in the 
35 States that have them, because they consistently exceed a 
borrower's ability to repay (though not a lender's ability to 
collect, via postdated check or ACH). As to whether people 
already struggling with debt fare better with or without access 
to additional high-interest credit, an excerpt from Policy 
Solutions follows:

        Rather than being ``thin file'' or ``no file'' 
        consumers who are creditworthy but lack access to 
        mainstream credit, most payday loan borrowers are 
        ``thick file'' consumers who have substantial 
        experience with debt. More than half of payday loan 
        applicants carry credit card debt, two in five payday 
        borrowers own homes (many with mortgages), and many 
        also hold student loans, auto loans, and other debt. 
        Typical payday loan applicants have poor credit scores 
        in the low 500s, indicating an assessment by credit 
        reporting agencies that payday borrowers are already 
        overburdened with debt and/or struggling to meet 
        financial obligations.

        Fifty-eight percent of payday loan borrowers have 
        trouble paying their bills at least half the time, and 
        7 in 10 use loans to cover ordinary living expenses, 
        such as rent or utilities. Payday borrowers' having 
        little discretionary income helps explain why 79 
        percent in Pew's survey support limiting the size of a 
        loan repayment to a small amount of each paycheck.

        Whether it is wise to use short-term credit to cope 
        with persistent cash shortfalls is debatable, and 
        policy makers surely will continue to examine the 
        merits of promoting credit for consumers who are 
        already indebted and struggling to make ends meet 
        especially when that credit comes at significantly 
        higher cost than mainstream products. It is entirely 
        possible that consumers who are already struggling with 
        debt have financial problems that cannot be solved by 
        obtaining more credit. But for those who use credit, 
        requiring loans to have affordable installment payments 
        that predictably amortize to a zero balance can avoid 
        creating an unsustainable reliance on getting new loans 
        to deal with shortfalls caused by repaying old ones. 
        Thus it becomes clear why 90 percent of payday 
        borrowers in Pew's survey favor allowing the loans to 
        be repaid in installments.

Q.7. In your written submission to this Committee dated March 
24, you discussed in-depth a report from the CFPB, CFPB Data 
Point: Payday Lending that was not publicly available until the 
following day, March 25. How did you come to have access to 
this report ahead of its public release?

A.7. Media members with embargoed copies of reports sometimes 
call Pew for comment while they work on stories in advance of 
an embargo lifting. In these instances, media members may share 
embargoed copies of a report in order to gain Pew's perspective 
on the report for their piece. Pew received the CFPB report on 
March 24 in this way in order to provide comments to the media.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
                        FROM NICK BOURKE

Q.1. Mr. Bourke, Harris Interactive recently conducted a 
national survey that found that payday loan borrowers indicated 
their experience was better than expected or as expected 96 
percent of the time in regards to terms and 92 percent of the 
times in regards to cost. It also found that 84 percent of 
borrowers said it was very easy or somewhat easy to repay their 
loans. Given this survey's result and the fact that consumers 
appear to value the option of payday loans, how does this 
reconcile with the ever present criticism of payday lenders 
from various advocacy groups?

A.1. Pew has also found that people in difficult circumstances 
are grateful to receive credit And because payday loans are 
usually due on the day a customer receives income, they are 
indeed repaid, though usually followed by a quick reborrow. 
This additional borrowing is a result of a lump-sum repayment 
that consumes an average of 36 percent of a person's bi-weekly 
income. Customers usually cannot afford to cover basic expenses 
after repaying a lump-sum loan. An excerpt from How Borrowers 
Choose and Repay Payday Loans follows:

        In deciding whether to borrow from a payday lender, 
        more than 3 in 4 borrowers rely on lenders to provide 
        accurate information about the product, and lenders 
        describe loans as ``safe,'' ``a sensible financial 
        choice,'' and ``the best alternative to meet their 
        current needs'' for a ``one-time fixed fee.'' The 
        product's stated 2-week duration appeals to the 
        borrower's desire for a quick cash infusion as well as 
        the conflicting desire not to be in ongoing debt. In 
        reality, both desires cannot be met. But a payday 
        loan's unrealistically short repayment period suggests 
        otherwise by enabling people in difficult situations to 
        think that the loan can solve their problem at an 
        affordable fixed cost so they can avoid asking for 
        help, cutting back further, or creating another ongoing 
        bill.

        The ultimate cost and duration of the loans are highly 
        unpredictable and bear little resemblance to their 2-
        week packaging. Average borrowers end up indebted for 5 
        months, paying $520 in finance charges for loans 
        averaging $375, largely because they see their only 
        choices as making a lump-sum repayment retiring their 
        entire debt, which they cannot afford, or paying fees 
        to continuously pay back and reborrow the loan, which 
        they can afford but which does not reduce what they 
        owe. Once they have borrowed, neither choice is viable, 
        leaving them indebted far beyond their next payday. 
        This experience leaves borrowers torn--grateful to have 
        received respectful customer service and credit when 
        they sought it, but feeling taken advantage of by the 
        loan's cost and frustrated by the difficulty of 
        repayment.

Q.2. A study entitled, ``Consumer Borrowing After Payday Loan 
Bans'' was recently published by Jacob Goldin and Tatiana 
Homonoff professors at Princeton and Cornell. The study 
examines the changes in consumer borrowing behavior when they 
lose access to payday loans, specifically the effect of payday 
loan restrictions at the State level. The study finds that 
payday loan bans do not reduce the amount of individuals who 
take out alternative financial services products, but instead 
force consumers to choose different inferior credit options. Do 
you believe research should continue to be to done to fully 
understand how regulations will affect consumers and their 
access to credit, before more haphazard rules and regulations 
for the short-term lending industry are enacted? Has PEW 
considered increasing their research on payday lending in an 
effort to focus on how to provide and not limit credit options 
for consumers?

A.2. Pew has conducted extensive research on payday lending, 
and has studied the literature on the topic. It is unclear 
whether people fare better or worse with access to high-
interest loans, but it is very clear that they fare better with 
loans that have affordable (usually installment) payments 
compared to high-interest loans that have balloon payments. 
Pew's policy recommendations show how loans can be better for 
borrowers and viable for lenders, alleviating the substantial 
problems in the small-dollar, high-cost credit marketplace. The 
recommendations follow:

1. Limit Payments to an Affordable Percentage of a Borrower's Periodic 
        Income

    Research indicates that for most borrowers, payments above 
5 percent of gross periodic income are unaffordable.
    Any small-dollar cash loan should be presumed to be 
unaffordable, and therefore prohibited, if it requires payments 
of more than 5 percent of pretax income (for example, a monthly 
payment should not take more than 5 percent of gross monthly 
income). Lenders should be able to overcome this presumption 
only by demonstrating that a borrower has sufficient income to 
make required loan payments, while meeting all other financial 
obligations, without having to borrow again or draw from 
savings.
    This 5 percent affordability threshold, which is based on 
survey research and analysis of market data, is a benchmark 
that policy makers can use to identify small-dollar loans that 
pose the most risk of harm or unaffordability. It generally 
will result in installment loans that have terms of months, 
rather than weeks, but the loan duration can be self-adjusting 
depending on the income of the borrower. It is also flexible 
enough to accommodate various policy choices regarding maximum 
loan size, duration, or finance charge. Normal supervision can 
assess compliance, so this recommendation does not necessitate 
a database. Borrowers will remain responsible for deciding how 
many loans to take and how often to use them.
    For calculation purposes, required payments would include 
principal, interest, and any fees. To discourage loan splitting 
or other methods of frustrating this policy, payments from all 
loans by a given lender should be considered together. 
Examiners should treat frequent refinancing or ``re-aging'' of 
loans as evidence of unaffordability and poor underwriting.

2. Spread Costs Evenly Over the Life of the Loan

    It is important to prevent front-loading of fees and 
interest on installment loans. Experience shows that front-
loading practices make the early months of the loan 
disproportionately more profitable for lenders than the later 
months, creating incentives for them to maximize profit by 
encouraging borrowers to refinance loans before they are fully 
paid off (a process known as loan ``flipping'' or 
``churning'').
    If fees other than interest are permitted, require them to 
be earned evenly over the life of the loan. Any fees, including 
origination fees, that lenders fully earn at the outset of the 
loan create a risk of loan flipping. Therefore, fees should be 
refundable to the borrower on a pro rata basis in the event of 
early repayment.
    Require all payments to be substantially equal and amortize 
smoothly to a zero balance by the end of the loan's term.
    Prohibit accounting methods that disproportionately accrue 
interest charges during the loan's early months. Such front-
loading schemes, often known as the ``rule of 78s'' or ``sum of 
digits'' methods, encourage loan flipping, because a lender 
earns far more interest income at the outset of the loan than 
in later months.

3. Guard Against Harmful Repayment or Collection Practices

    Payday and deposit advance lenders have direct access to 
borrowers' bank accounts for collecting loan repayment. Lenders 
use this access to ensure that they are paid ahead of other 
creditors, an advantage that allows them to make loans without 
having to assess the borrower's ability to repay the debt while 
also meeting other obligations. Although this arrangement 
shields the lender from certain risks and may facilitate 
lending to those with poor or damaged credit, it comes at the 
cost of making consumers vulnerable to aggressive or 
unscrupulous practices. High rates of bounced checks or 
declined electronic payments are indicators of such practices. 
Borrowers lose control over their income and are unable to pay 
landlords or other creditors first.
    Treat deferred presentments as a dangerous form of loan 
collateral that should be prohibited or strictly constrained. 
Deferred presentment or deferred deposit loans require 
borrowers to give the lender the right to withdraw payment from 
the borrower's bank account. This requirement is fulfilled 
through a personal check that is postdated to the borrower's 
next payday or through a nonrevocable electronic debit 
authorization. Because of the inherent dangers, State laws 
generally authorize deferred presentments only for loans that 
are understood to serve short-term, urgent liquidity needs. Of 
the States that have deferred deposit loans, a majority set the 
maximum term at 6 months or less, and a majority set the 
maximum loan amount at $500 or less.
    Policy makers may reasonably choose to prohibit deferred 
presentments if they do not want payday lenders to operate. If 
allowed, deferred presentments should never apply for more than 
6 months or for loans of more than $500.
    Prevent unscrupulous lenders from abusing the electronic 
payments system, and make it easier for consumers to cancel 
electronic payment plans. Some installment lenders establish 
automatic repayment plans using electronic payment networks. 
Although this mechanism can help lower the cost of small-dollar 
loans and make loan management more convenient, evidence shows 
that it also exposes consumers and their checking accounts to 
significant risk. Regulators should establish a balance between 
lender and borrower interests, especially in cases--such as 
online lending markets--where there is evidence of aggressive 
lending or collections behavior. Pew recommends making it 
easier for consumers to stop automatic withdrawals, placing 
limits on the number of NSF fees that borrowers may pay, and 
closing the electronic payments system to merchants that abuse 
it (as evidenced by repeated attempts to withdraw funds from 
borrower accounts, excessive use of NSF fees, or other 
aggressive behavior). These goals may be accomplished through 
regulatory action and stronger oversight of the electronic 
payments system by the banks that operate it.
    Monitor and respond to signs of excessively long loan 
terms. Some high-interest installment payday lenders set 
excessively long loan terms, with only a small portion of each 
payment reducing the loan's balance. Therefore, policy makers 
should consider establishing maximum loan terms. These should 
take into account a borrower's financial capability, measured 
by income or ability to repay, as well as the size of the loan 
principal. Colorado demonstrates that for average payday 
borrowers, 6 months is long enough to repay $500, and in 
consumer finance installment loan markets, approximately 1 year 
is usually sufficient to repay $1,000.

4. Require Concise Disclosures That Reflect Both Periodic and Total 
        Costs

    Research shows that small-dollar loan borrowers focus on 
the periodic cost of borrowing but often struggle to evaluate 
overall cost, making it difficult to compare other loan options 
or to decide whether to borrow, adjust budgets, or take other 
actions. All loan offers should clearly disclose:

    The periodic payment due.

    The total amount to be repaid over the life of the 
        loan.

    The total finance charges over the life of the 
        loan.

    The effective annual percentage rate, or APR, of 
        the loan.

    These four numbers should be displayed clearly, and with 
equal weight, to encourage borrowers to consider both periodic 
and long-term costs. To facilitate comparison shopping, all 
loan costs should be stated as interest, or interest plus a 
standard fee. If a fee is permitted in addition to interest, it 
should be included in the calculation of finance charges and 
APR, based on the loan's stated term. As with other consumer 
financial products such as credit cards, regulators should 
require simple, standardized disclosures showing maximum 
allowable charges at the time of application as well.

5. Continue To Set Maximum Allowable Charges on Loans for Those With 
        Poor Credit

    Research shows that lenders generally do not compete on 
price in these markets serving those with poor credit, which is 
why almost every State has laws that set maximum allowable 
rates on small-dollar loans. Without regulations, prices reach 
levels that are highly disproportional to lender cost, or far 
higher than necessary to ensure access to credit. Colorado's 
payday loan law shows it is possible to ensure widespread 
access to loans of $500 or less for people with poor credit 
histories, at prices far lower than those charged for 
conventional payday loans. It is also possible that such credit 
could be available at rates lower than the average APR of 129 
percent in Colorado. In States that have permitted higher 
interest rates than this, storefronts have proliferated, with 
no obvious additional benefit to consumers.
    States may reasonably choose to set maximum annualized 
interest rates of 36 percent or less if they do not want payday 
lenders to operate. States may also reasonably choose to allow 
interest rates higher than 36 percent if they do want payday 
lenders to operate. But even when regulations require all loans 
to have affordable repayment structures, there is insufficient 
research to know whether consumers will fare best with or 
without access to high-interest installment loans. Thus Pew 
does not recommend law changes in the 15 States that do not 
have payday lending, because such a change may not benefit 
consumers. In the 35 States that have conventional lump-sum 
payday lending, lawmakers should require loans to have 
affordable payments and then set maximum annualized interest 
rates according to whether they want payday lenders to operate.
    These recommendations are intended to apply to all consumer 
cash loans of several thousand dollars or less, regardless of 
provider type (bank, nonbank) or product type (payday loan, 
installment loan, cash advance), exclusive of loans secured 
through pledge or deposit of property. They are based on 
findings documented in Pew's Payday Lending in America series, 
available at: www.pewtrusts.org/small-loans.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN
                      FROM NATHALIE MARTIN

Q.1. The FDIC and consumer groups have advocated for small-
dollar products that have four features:

  a.  reasonable APRs;

  b.  repayment period longer than 90 days;

  c.  ability to repay principal;

  d.  and the borrower demonstrates an ability to repay the 
        loan in full.

    Some in the industry have responded to this criticism of 
the payday product by moving toward installment loans. Enova 
offers a 7 months and 13 months installment product in New 
Mexico with APRs of 389 percent and 393 percent, respectively.
    As industry moves toward the lengthening repayment terms, 
is it possible to address the issue of affordability of small-
dollar credit products without addressing all four of the 
features mentioned? Please explain.

A.1. In my opinion no.

Q.2. Payday loans are advertised as 14-day or 30-day loans. 
Lenders market small-dollar credit loans, such as payday loans, 
as a ``safe,'' ``sensible financial choice,'' and ``the best 
alternative to meet their current needs'' for a ``one-time 
fixed fee.'' Pew found that borrowers were on average indebted 
for 144 days, and CFPB found that they were indebted for 199 
days. The Online Lenders Alliance consumer study shows that 
consumers have an average of 70 to 120 days of indebtedness per 
year.
    How do these findings reinforce that the short-term small-
dollar products are not in fact designed to be repaid according 
to their terms?

A.2. The findings absolutely lead to this conclusion. The 
entire business model is based upon repeat users, and the 
industry has said so in many contexts publicly. This fact comes 
out in litigation all over the country, as well as in empirical 
studies. There is little profit in the short term use.
    The CFPB report released in March also showed that for 
first time users, 15 percent of customers pay off and don't go 
back. 20 percent default. That means 64 percent do not use 
these as a short term product. Those 64 percent are the bread 
and butter of the business model, the ones the lenders want in 
their portfolios.

Q.3. In your written testimony you stated that ``in States 
where complex statutes are passed to limit high-interest 
lending . . . lenders find ways around those laws by changing 
the attributes of the loans to avoid the laws, fitting within 
exceptions created by other laws on the books, or becoming 
credit service organizations (CSOs), which are exempt from the 
laws.'' You further stated this is a `` . . . complex game of 
whack-a-mole makes regulating State by State an expensive yet 
ineffective endeavor.''
    How would you propose addressing this issue?
    What actions would you recommend the Consumer Financial 
Protection Bureau (CFPB) take to provide a level of uniformity 
and Federal oversight of these products?

A.3. The CFPB should implement broad rules that apply to all 
small dollar loans products, that require underwriting to 
ensure the borrower can pay his or her regular bills and also 
repay the loans, both principal and interest. The CFPB should 
limit the number of loans that can be taken out and require 
that in order to be enforceable, the loans must be placed in a 
national database and tracked.

Q.4. The most recent report released by the CFPB shows that 58 
percent of borrowers who take out payday loans on a monthly 
basis are recipients of some kind of benefits--Social Security, 
SSDI, unemployment--or retirement income. The White Paper they 
released last year found that 22 percent of all borrowers are 
on some form of public assistance or relying on retirement 
income.
    Payday is usually advertised as a short-term stopgap to 
fill a consumer's financial needs until the borrower receives 
some new source of income. This is not the case for borrowers 
on a fixed income from Government assistance or in retirement.
    How safe are these products for individuals living on fixed 
incomes?

A.4. The products are unsafe for almost everyone who uses them 
(the exception being those with real, rare, emergencies who 
expect a great deal more income or assets in the future). They 
are particularly bad for those on fixed income. These loans 
make it much harder to make ends meet during the next benefit 
period. I also know some lenders specialize in ``serving'' 
people on disability or social security. They know the 
borrowers involved will never be able to pay back the principal 
and that is part of the business palm.

Q.5. Should we be concerned that Government benefits payments 
are going to companies that may be taking advantage of 
borrowers?

A.5. This is a huge problem and yes we should be very 
concerned. As mentioned above, I have heard of a small town in 
New Mexico where five lenders line main street and all or four 
of five specialize in making loans to people who receive public 
benefits. This is how I learned firsthand that lenders do not 
want anyone paying off the principal. It would clearly be 
impossible the way they loan to people on such a low fixed 
income. That is part of the model. Make loans that people will 
not be able to pay off and make money on fees forever.
    We know lenders also discourage people from paying off 
their loans and in one reported case in New Mexico, an employee 
of a lender told a borrower that the borrower was better off 
using their tax return at Walmart. That opinion is attached. 
Some lenders also call borrowers on their way home from 
repaying a loan and offer them another loan, this time in a 
larger amount, perhaps in hope that this time, the loan will 
not be paid off.
    There are other situations in which this same thing is 
happening, meaning that Federal benefits are going to high-cost 
lenders. For example, some tax preparers themselves take most 
of the primary welfare benefit in America today, the earned 
income tax credit, which is designed to alleviate poverty. In 
both cases, the situation you mentioned and the situation with 
the tax preparers, we are literally funneling taxpayers' money 
away from the intended beneficiaries and into the lender's 
pockets. The lenders in turn give political campaign 
contributions to politicians who will ensure that the law 
continues to support these practices. No one benefits except 
the lenders and the politicians who get the contributions. 
Everyone else in society suffers.

Q.6. Payday loan contracts are considered simple in comparison 
to the terms associated with other consumer credit products, 
such as mortgages, credit cards, and other alternative small-
dollar credit like auto-title and installment loans. However, 
it is clear that borrowers have trouble understanding and 
assessing their ability to repay since consumers who use these 
products are in continuous debt.
    Can you explain why it is common for borrowers to 
inaccurately predict their ability to repay in full the loan 
and their likelihood for taking out subsequent loans?

A.6. Some borrowers are confused about the rate because the 
rates are stated in terms on $15 per $100 borrowed or $20 per 
$100 borrowed. They think this is 15 or 20 percent per annum 
but the rate is just for 2 weeks or less. The actual interest 
rate on such a loan is 390-500 percent per annum. They think it 
sounds cheaper than a 25 percent credit card, for example. Also 
people in society have trouble doing math.

Q.7. What type of disclosures would be most useful?
    How would disclosing APRs help borrower assess the actual 
cost of the loan?

A.7. There was a great study done where researchers wrote the 
APRs and some other information on the outside of the envelope 
people received when applying for a payday loan. See Marianne 
Bertrand and Adair Morse, Information Disclosure, Cognitive 
Biases and Payday Borrowing, University of Chicago Booth School 
of Business (2009), available at http://ssrn.com/
abstract=1532213, last accessed August 7, 2013. This approach 
worked meaning that people who had other options or did not 
really need the money were deterred from taking out the loans. 
The approach taken in this article should be considered 
carefully.
    In my experience, lenders try not to draw attention to the 
APR, try to distract borrowers from seeing it, if they provide 
the APR at all.

Q.8. Lenders offerings small-dollar installment credit products 
claim they can help borrower build a credit history and improve 
credit scores. Enova testified that they have been working to 
foster relationships with the major credit bureaus, and hope to 
help consumers build credit history.
    Can you explain how these products have improved the credit 
scores for individual consumers?

A.8. Very few high-cost lenders report to the credit agencies 
meaning that use of these products has helped very few. I do 
know that World Finance has big signs outside their storefronts 
saying that they do report to credit agencies. I suppose this 
could help a few consumers and I know for fact that some 
consumers use this lender for that reason, rather than other 
high-cost lenders. Of course some people will ultimately 
default on high-cost loans and the reporting will hurt those 
consumers.
    I would like to know specifically what Enova has actually 
done to help consumers on this issue.














                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
                      FROM NATHALIE MARTIN

Q.1. Do you think most unbanked or underbanked Americans are 
capable of handling their own finances, or do you feel that 
Government needs to step in and ``protect them from 
themselves'' by such actions as credit rationing or denying 
them certain credit products?

A.1. What the Government needs to do is to listen to what the 
American people have to say about regulating high cost loans, 
rather than to this industry and the politicians who have 
received campaign contributions from them. The American public, 
including people from both political parties, has spoken loudly 
and clearly. The public favors interest rate caps of 36 percent 
or less on all consumer loan products. No survey or empirical 
study has found otherwise. This country has always had double 
digit interest rate caps since its founding. Interest rate caps 
are part of our culture and our heritage. They are also common 
in other developed democracies. Having no caps is a relatively 
recent phenomenon, beginning in the late 1970s and early 1980s. 
Most people are shocked and disturbed to hear that it is legal 
to lend money at over 36 percent and some think that 36 percent 
is itself abusive.
    What is presumptuous and paternalistic is for politicians 
to listen to the high-cost loan industry rather than their 
constituents on this point. If constituents knew their own 
elected officials' true views and voting records on these 
issues, the public might vote certain politicians out of 
office.

Q.2. Some argue that States should not be rationing credit 
because in some cases consumers act irresponsibly and get 
deeply in debt. Do you agree, or do you support Government 
stepping in and rationing credit? Some also argue that loan 
prices should be set by the free market and should not be 
subsidized by the Government. What do you think about this 
issue? Should unbanked and underbanked consumers who pose 
higher credit risks have their loans subsidized or be given 
some type of governmental support, or should rates be set 
through the free market?

A.2. Rationing is having the Government allow only a particular 
amount of something (such as gasoline or food) when there is a 
shortage. Clever use of the word, but I am not buying it. There 
has never been more credit in any economic system in history 
than what we have seen in the United States in the last decade.
    As a society, we do the opposite of rationing credit. The 
U.S. recently has given virtually unlimited credit to people 
who have no way of paying it back, helping them dig a deeper 
financial hole and providing more barriers to entry to the 
middle class. There is more credit in the system than there 
should be, evidenced by the recent financial crisis. We gorged 
ourselves on it and it crashed the global economy.
    My own research and that of many others show that people 
take out many payday and title loans, then default, yet lenders 
still make money off the loans.
    Existing mainstream lenders could serve more low-end 
consumers and still make a profit. They have chosen not to. 
They would just rather invest in options that are more 
profitable, like high-cost lenders.
    Even assuming that some credit options will go away based 
upon future regulation, this is not rationing. I think 
consumers will be better off once some of the market players 
are gone. Twenty-two States plus the District of Columbia 
agree. This is not radical, just common sense. Credit at any 
cost? No think you. Some loans are bad enough that they should 
be illegal and are illegal in many States.

Q.3. As you undoubtedly know, the Post Office Inspector 
General's Office has recently proposed that the Post Office be 
allowed and encouraged to begin offering small loans and other 
alternative financial services products through partnerships 
with banks and credit unions. Their report claims, for example, 
that the Post Office could offer a $375 loan repayable over 5 
to 6 months at a rate of 28 percent APR that would generate a 
profit of $48 for the Post Office (and its banking partners). 
Do you find the analysis persuasive?

A.3. So far this is not an analysis. Feasibility and 
profitability studies still need to be done. What is exciting 
about the model, which is used in many countries around the 
world, and exciting about the idea in general, is that the 
infrastructure of the post office already exists.
    The U.S. postal service is being forced by Congress to 
prefund retiree health benefits, which itself is a questionable 
requirement imposed by Congress. If Congress is going to stick 
with this requirement, it should in turn approve the USPS to 
provide these loans. This would be a way to use the huge postal 
infrastructure to benefit consumers. Of course this assumes the 
resulting credit would be cheaper for consumers, something the 
future studies would have to confirm. The studies would also 
need to confirm that the post offices would generate at least 
some minimal income but on this side of the equation, it seems 
they would. Even a little profit for the post office would be a 
win-win. The post offices are already in operation and adding 
this feature would not significantly increase overhead or 
operations costs.
    Banks might themselves complain about how this could 
conceivably eat into their profits but do they have the 
standing to make that argument, now that they have pulled 
branches out of so many neighborhoods while at the same time 
providing funding and infrastructure for the high-cost lending 
industry? Let's hope not.

Q.4. The Internet has revolutionized Americans' buying habits 
and greatly increased their product choices. Consumers today, 
regardless of where they are located, can obtain essentially 
whatever commercial product they need when it is not available 
locally by going online, getting the best available price and 
having it delivered to their door. Should consumers in every 
State have the same ability to get well-regulated small loans 
and other financial services through the Internet if such 
products are not otherwise available locally?

A.4. Absolutely. Of course the question is ``what is a well-
regulated loan?'' For me, it includes a reasonable interest 
rate, underwriting for ability to pay both regular bills and 
principal and interest on the loans, and a limit on the total 
number of loans a consumer can take out.

Q.5. Michael Flores' recent study, Online Short-Term Lending, 
points out that the primary alternatives to payday loans are 
often significantly more costly than payday loans. Given that 
finding, would underserved consumers who now rely on 
potentially less costly payday loans be helped or harmed if 
additional States or the CFPB prohibited or severely restricted 
access to these loans? If credit products like payday loans or 
banks' deposit advances are eliminated, what happens to the 
demand for such products?

A.5. I strongly disagree with the idea that payday loans and 
other high-cost loans of 400-1,100 percent interest are cheaper 
than these other costs, overdraft fees, etc. . . . The data do 
not uniformly support this conclusion. Moreover, many studies 
show that people are better off once payday and other high-cost 
lenders leave their State. I have seen no proof from any source 
that people are better off in places where high-cost loans are 
available. If anything, the opposite is true.

Q.6. Do you support or oppose the PEW recommendations? Could 
you please explain your reasoning?

A.6. I am not familiar with all of the PEW recommendations, but 
can agree that these features are needed in the short-term loan 
market:

    reasonable APRs;

    repayment periods longer than 90 days;

    loan structures that permit borrowers to repay 
        principal along with interest as a loan progresses; and

    underwriting for all loans.

    I myself believe that other features are also desirable. 
There must be a limit on the number of loans people can have 
out at any one time on order to make the underwriting make 
sense. Also, I am less inclined to favor a law like Colorado's, 
which allows interest rates of up to 200 percent, and less 
tolerant in general of triple digit interest rates. This is in 
part because I have seen the harm done to many consumers who 
are stuck in these loans for long periods of time, and who are 
deeply sorry they took out the loans, and also because I know 
the public supports interest rate caps, even the conservative 
public.
              Additional Material Supplied for the Record
LETTER FROM THOMAS J. CURRY, COMPTROLLER OF THE CURRENCY, SUBMITTED BY 
                             CHAIRMAN BROWN



 LETTER FROM JOHN W. RYAN, PRESIDENT AND CEO, CONFERENCE OF STATE BANK 
                              SUPERVISORS
                              



   STATEMENT SUBMITTED BY THE AMERICAN FINANCIAL SERVICES ASSOCIATION
   



                   EMAIL SUBMITTED BY SENATOR VITTER