U.S. crackdown on payday lenders sharpens political battle lines

By Lisa Lambert and Elizabeth Dilts

WASHINGTON/NEW YORK, June 2 (Reuters) - The U.S. government's move on Thursday to restrict payday lenders' ability to profit from high-interest loans marks its first crackdown on an industry accused of preying on desperate consumers but also viewed as a last-ditch source of money.

The Consumer Financial Protection Bureau unveiled a proposal that would require lenders to use a "full-payment" test to determine whether borrowers can afford each loan payment and still meet basic living expenses.

It also would bar lenders from taking auto titles as collateral and make it difficult for them to "push distressed borrowers into reborrowing," according to a summary of the proposal released by the agency.

"The CFPB is taking a major step toward reining in predatory debt traps that exploit the financial struggles of millions of economically vulnerable Americans and often leave them worse off than before," Carmel Martin, executive vice president of policy at the Center for American Progress, said in a statement.

Payday lenders, who have been bracing for new regulation by the CFPB since 2010, when the Dodd-Frank Wall Street financial reform law gave the agency authority over that part of the loan market, disagreed.

The Community Financial Services Association of America, the leading advocacy group for the industry, said the proposal would hurt consumers who rely on the loans as their only source of credit.

"What will happen ... if this rule goes into effect is it will deprive people of this option," CFSA Chief Executive Officer Dennis Shaul said on a media call. Borrowers "will turn to other sources, which are basically loan sharks or ... a loan through the Internet."

The CFPB has become a political hot potato, with Republicans, including presumptive 2016 presidential nominee Donald Trump, questioning its role and vowing to undermine its authority.

They argue that any attempt to restrict short-term loans of less than $500 would cut off struggling consumers' access to a regulated financial lifeline.

Democrats, who largely back the CFPB's proposal, say a rule is necessary to rein in abusive payday lenders, who can charge fees as high as 390 percent.

"Donald Trump wants to strip the U.S. government's power to apply rules to payday lenders, abolish this critical consumer watchdog, and roll back the other Wall Street reforms that we put in place after the financial crisis," Democratic presidential front-runner Hillary Clinton said in a statement.

"Working families deserve a president who will look out for them - not payday lenders and special interests on Wall Street."

Share prices for lenders Regional Management Corp and World Acceptance Corp fell 1.8 percent and 4.8 percent, respectively, after the bureau's proposal was announced.

NEW PROPOSAL

The Federal Bureau of Investigation and Internal Revenue Service have cracked down on alleged fraud and racketeering in the industry. Payday lenders are one of the targets of "Operation Chokepoint," an FBI investigation into business relationships between banks and potential law-breaking companies.

Payday lenders typically cater to low-income borrowers who need cash in a pinch but cannot access financing from mainstream banks. The name comes from the idea that a borrower would take out an emergency loan and repay it with the next paycheck. Since the loans are often not collateralized, lenders take the risk of not being repaid and charge higher rates.

The CFPB proposes to place caps on the number of short-term loans and to limit lenders' ability to repeatedly debit a borrower's bank account for an outstanding payment. It says failed withdrawal attempts rack up bank fees for borrowers.

The proposal presents two alternatives for longer-term loans. One caps interest rates at 28 percent and the application fee at $20. The other is an installment loan of equal payment amounts, with the loan's total cost capped at 36 percent.

The fight over the proposal will span months. The agency will evaluate comments on the proposal, due Sept. 14, before issuing final regulations. It is also beginning a review of "other potentially high-risk loan products and practices" such as open-end credit.

CFPB Director Richard Cordray was scheduled to discuss the proposal later on Thursday at a hearing in Kansas City, Missouri.

(Reporting by Lisa Lambert; Editing by Diane Craft and Paul Simao)