Protect Borrowers Proposes New Offices Of Supervision Policy For State Financial Regulators

As we have chronicled in our blog, states are increasingly moving to fill the consumer-protection void created by the CFPB’s dramatic retreat from supervision, enforcement and rulemaking. State legislatures are considering and enacting new consumer-finance protections; state attorneys general are bringing more enforcement actions under state UDAP and other laws, often in bipartisan and multistate coalitions; and state financial regulators are expanding their supervisory and enforcement efforts. States also have challenged federal efforts to restrict their authority to protect consumers. As federal oversight continues to shrink, the states increasingly are becoming the front line of consumer financial protection.

With the federal government pulling back from consumer financial supervision, a new proposal from Protect Borrowers would encourage state financial regulators to step into the breach by creating dedicated “Offices of Supervision Policy.” This appears to be an effort to replicate at the state level the expansive, aggressive. and sometimes overreaching style of supervision that the CFPB was previously engaged in during the prior Administration.

Protect Borrowers, a nonprofit formerly known as the Student Borrower Protection Center, released the proposal on August 27 in a memorandum authored by Lorelei Salas, a former Director of Supervision at the CFPB, and Winston Berkman-Breen, Protect Borrowers’ Legal Director and a former Director of Consumer Advocacy at the New York Department of Financial Services. 

The proposal starts with a basic premise: states already have broad supervisory authority over state banks and nonbank financial companies, but they generally exercise that authority through periodic examinations. The authors argue that this approach is too slow and resource-intensive to address rapidly developing risks, particularly those associated with artificial intelligence and other financial technologies.

What Would an Office of Supervision Policy Do?

The proposed offices would supplement, rather than replace, traditional examination staffs. They would include experienced consumer-finance attorneys, technologists and other specialists who could work with examiners on complex issues involving AI, automated decision-making, product design and consumer behavior.

Perhaps more importantly, the offices would enable regulators to move beyond the traditional examination cycle. Assuming that they have the authority to do so, regulators could conduct targeted information requests, limited-scope reviews, industry surveys, market monitoring and rapid-response investigations when emerging consumer problems arise.

The proposal also calls for regulators to use complaints and other data (including their own complaint information, CFPB and FTC databases, regulatory filings, news coverage and social media) to identify institutions and products presenting the greatest risks to consumers, even if the sources and validity of those complaints and other data have not been verified. The memorandum fails to acknowledge that for many important reasons we discuss in our recent blog, the CFPB has recently eliminated complaint narratives from the CFPB website.

AI and UDAAP Would Be Particular Areas of Focus

The proposal reflects the growing difficulty of supervising financial products that rely on sophisticated technology. The memorandum argues that technologists could help examiners test products, evaluate automated systems and recreate credit-decisioning models.

Attorneys could play a similarly important role, particularly in states with UDAAP authority. The memorandum suggests that examiners sometimes may rely on more straightforward regulatory provisions rather than undertake difficult UDAAP analyses. It then argues that supervision-policy attorneys could help identify potential legal violations and develop the legal theories supporting supervisory findings. It does not address any procedural or substantive restrictions to protect against overreaching.

What About Cost?

The authors acknowledge that state regulators already face significant resource constraints. They nevertheless contend that an Office of Supervision Policy could be financed through the industry assessments and fees that many state regulators already impose on banks and nonbanks. The memorandum also suggests that agencies could initially use consultants or contract personnel if dedicated funding is unavailable.

Having experienced this kind of expansive supervision by the CFPB, regulated industries are unlikely to be supportive. Whether state legislatures would agree that the benefits justify the additional cost, including the impact on innovation and competition is, of course, another question.

What Does This Mean for Financial Institutions?

If states adopt this proposal, financial institutions could encounter a more continuous form of state supervision. Instead of waiting for the next scheduled examination, regulators with authority to do so could request information about a particular product or practice at any time, conduct targeted reviews, and use outside data to determine where supervisory resources should be directed.

The proposal also contemplates greater use of anonymized “supervisory highlights” to alert other institutions to problems identified during examinations and communicate regulators’ expectations.

For institutions operating in multiple states, however, the proposal raises an obvious question: Will a proliferation of state supervision-policy offices produce a patchwork of different supervisory expectations and information requests?

That may ultimately be the most significant issue for the industry. The states already have substantial supervisory authority. The Protect Borrowers proposal would give them a blueprint for using that authority more aggressively, continuously and technologically. For the reasons mentioned above (including, most importantly the cost of launching this initiative in many states and expected strong industry opposition), we are very skeptical that this proposal will gain traction in most states. Finally, Protect Borrowers does not explain what role, if any, it will play in organizing, launching and providing guidance to any states that express interest in creating an office of supervision policy.

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