What does the CFPB’s proposed ban on arbitration mean for community banks?

As widely reported in the media last week, the CFPB introduced a long anticipated proposal to prohibit banks and consumer finance companies from using mandatory arbitration clauses to block class action lawsuits. Several publications have weighed in on the merits of this proposal and its impact on the financial industry. But little has been written about the impact this proposal will have on smaller financial institutions. Although consumer class actions involve large banks far more frequently, community banks are not immune to class action litigation. Thus, it is important to understand the changes that the CFPB’s proposal would require.

The CFPB’s proposal is not an outright ban on arbitration provisions, but rather would prohibit banks from using mandatory arbitration provisions to insulate themselves from class action litigation. Although banks could still use arbitration provisions with consumer loans and accounts, new contracts would be required to carve out class action litigation from the scope of mandatory arbitration. As a practical matter, this would render arbitration provisions worthless except in cases where banks have a very individualized dispute with a customer.

The mandatory availability of class actions instead of arbitration would likely mean a substantial increase in costs for banks. The cost increase would come from (1) rewriting contracts to ensure compliance with the new proposal; (2) attorneys’ fees in defending class litigation; and (3) settlements paid in class actions. The CFPB downplays the first cost in its report explaining the proposal. But the CFPB recognizes that financial institutions that face class actions—estimated by the CFPB to be well over 100 per year—would incur substantial costs. And while the several hundred thousand to several million dollar price tag of defending and possibly settling class action litigation may not be a major concern to large banks, that amount of money could bankrupt a community bank.

The CFPB dismissed the concerns raised by the Small Business Review Panel, in part because “the Bureau believes that small consumer finance entities face class litigation at a lower rate than entities that are not small.” While that is undoubtedly true, it does not mean that small banks are never face class actions. In fact, the CFPB points out that an average of one federal class settlement per year was against a small financial institution (and that does not count the class action suits that are filed and dismissed or class actions in state court). The CFPB also rejected the Panel’s concerns about the difficulty and expense of obtaining sufficient insurance to cover any class litigation expenses.

Based on its dismissal of the Small Business Review Panel’s concerns, the CFPB stated that it “is not proposing an exemption for small entities because it believes that the availability of class actions protects consumers who do business with small entities.” As a result, community banks that use arbitration provisions in connection with consumer loans and accounts may need to prepare for this change if the proposal is ultimately implemented.