The shifting landscape of consumer financial regulation

If you view the regulation of consumer financial services as a pendulum, the industry is at the peak of its oscillation. Industry participants would love nothing more than to see the regulation hit an equilibrium and exhibit little volatility in the future, but that is not what should be expected in the coming years.

The impending changes in consumer financial regulation will be driven by a reaction to increased regulation of the industry over the last five to six years. These changes will manifest in two ways.

First, there will be a continued regulatory focus on fair lending compliance and violations in the near term. Second, the incoming administration will attempt to curb the reach and authority of the Consumer Financial Protection Bureau (CFPB), the primary driver of federal consumer financial regulations.

Fair lending regulation

The recent rise in regulation has led to a tipping point by creating an extremely conservative consumer lending industry. Lenders are hyper-aware of possible regulatory and litigation risk, and they are becoming more conservative and risk averse in their operations.

These lenders have also absorbed the large expenses that came with the implementation and monitoring of these new regulations. These costs will be priced into the products being offered. Both the more conservative approach to lending and the higher costs have led to certain borrowers being “priced out” of products and limiting other borrowers’ access to credit.

In response, regulators will shift their focus from alleging that lenders have preyed upon and targeted a population of borrowers with predatory marketing, products and lax underwriting standards, to alleging that the very same lenders have now restricted that same population of borrowers and their access to credit.

In 2015, Patrice Alexander Ficklin, the CFPB’s director of fair lending and equal opportunity, released her office’s annual fair lending report. While referring to the residential mortgage markets, the reported stated that “given the tight credit environment of the last few years, our focus is on underwriting and redlining, though we also consider pricing policies and practices that present fair lending risk.”

Statements such as these are very frustrating for lenders who recognize that the tight credit market is a direct result from the regulations put in place by the CFPB.

This trend is already beginning to play out at the Department of Justice’s (DOJ) civil rights division. When a banking regulator identifies a pattern and practice of discrimination, which may violate federal law, the regulator must refer the matter to the DOJ, which decides if it will further investigate the matter.

At the end of 2012, the DOJ had 11 open fair lending investigations. At the end of 2013, it had 11 open investigations. At the end of 2014 they had 25 open investigations. By the end of 2015, the DOJ had 35 open investigations has risen to 35.

This is a disturbing statistic for those involved in consumer lending. The trend will continue into 2017, as the downstream effects of the too much regulation show that certain populations of borrowers are having difficulty accessing consumer credit.

CFPB structural reform

While the focus on fair lending is heating up, the new administration will be attempting to reform the CFPB which will also have a lasting mark on individual borrowers’ access to credit, the overall cost of consumer financial services and the future stability of the CFPB itself.

In order to understand the ramifications a restructuring of the CFPB would bring to consumer financial regulations, it helps to understand the agency’s structure, which was only accomplished given the perfect storm of a Democratic president with a Democratic-controlled Congress, at a time when the country was exiting one of the worst financial crises we had ever seen.

To say the political and social sentiment was anti-bank at the time is a drastic understatement. Given the aforementioned climate, the architects of the Dodd-Frank Act were able to create the CFPB to operate as independently as possible, making it a very powerful regulator.

The CFPB was placed under the Federal Reserve, with its budget derived from a fixed percentage of the Fed’s operating expenses. This allows the CFPB to escape congressional funding oversight. The CFPB was then given an organizational structure with the entire bureau reporting to a single independent director, which allowed the bureau to be nimble and implement new regulation without compromise.

However, this structure also removed the controls and necessary checks and balances inherent in organizations led by commission, or at the very least the control that comes with a director that serves at the pleasure of the president.

The CFPB’s structure and the continued political climate has allowed the the bureau to push the boundaries of consumer regulation while avoiding pushback from Republicans attempting to restructure or reign in its aggressive approach to regulation.

This all began to unwind in October, when the U.S. Court of Appeals for the D.C. Circuit held that “the CFPB is unconstitutionally structured,” given its independent single director structure. But this was quickly followed by the Republicans taking the White House in November.

The president can exercise his power to remove the director and his replacement may simply roll back the effects of the actions the CFPB has taken so far. Those of us in the consumer financial industry, however, would be left spending a great amount of energy and capital on compliance with rules and orders that could be reversed or revised as soon as another administration is voted into office.

The volatility of a drastic change in regulation driven by simply switching the priorities of the CFPB through a change in its director will not lead to steady regulation. Again, this would mean enormous costs that would not be absorbed by the industry participants, they will be priced into the cost of borrowing, harming the end consumer and again possibly limiting access to credit.

A better approach would be to pursue legislation such as the Financial Choice Act, which seeks to reform the CFPB in multiple ways, including tasking the bureau with the dual mission of consumer protection and competitive markets; replacing the current single director with a bipartisan, five-member commission subject to congressional oversight and appropriations; establishing an independent, Senate-confirmed inspector general; requiring the five-member commission to obtain permission before collecting personally identifiable information on consumers; repealing the authority to ban bank products or services it deems “abusive” and to prohibit arbitration; and repealing the CFPB’s indirect auto lending guidance.

Hopefully Congress will take this opportunity to give the CFPB the bipartisan traits it needs to survive, and provide a consistent approach to regulation as different administrations cycle through the White House in the years to come. If this was accomplished by Congress when drafting Dodd-Frank, we would not need to discuss these issues today.

An agency that wields as much power over consumer financial markets needs to be stable, not only for the operation of consumer lenders, but for the end consumer as well. Regardless of the approach the new administration decides to pursue, the one thing we know for sure is that the regulation of the consumer financial industry is about to shift yet again.

Craig Nazzaro is a member of Baker Donelson’s financial services team in Atlanta. He advises firms on all regulatory and compliance issues that impact the consumer lending industry, and defends them against charges of liability and any regulatory violations.

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