A new rule intended to give consumers greater protection against financial institutions will likely lead to a host of regulatory challenges for community banks, and even more worrisome, potentially costly litigation.

The Consumer Financial Protection Bureau on Monday issued a long-awaited rule that would ban banks from using mandatory arbitration clauses, which are commonly used in credit card accounts, to deny consumers the right to file class action lawsuits.

“The concern we’ve had all along is it potentially opens up the door to costly litigation,” said Jon Skarin, senior vice president at the Massachusetts Bankers Association, who deals with regulatory issues. “For a smaller bank that could be extremely costly and labor intensive. There could be better way to solve issues without the legal process.”

Skarin said at most community banks, there is unlikely to be a large number of customers with the same type of complaint. He also said many community banks already have a process to resolve customer complaints that has been created with guidance from state and federal agencies.

But that will not stop many institutions from having to rewrite their policies to comply with the new 750-page rule. Skarin also said the new rule could also require banks to restructure their agreements with third-party credit card providers.

The rule, which will apply to only new contracts, will take effect 60 days after it is published in the Federal Register and become enforceable after 241 days.

“Right now, many contracts for consumer financial products like bank accounts and credit cards come with a mandatory arbitration clause that makes it virtually impossible for people to sue the company as a group if things go wrong,” said CFPB Director Richard Cordray in statement. “By blocking group lawsuits, mandatory arbitration clauses force consumers either to give up or to go it alone – usually over relatively small amounts that may not be worth pursuing on one’s own.”

One example Cordray cited was when Wells Fargo opened millions of deposit and credit card accounts without the knowledge or consent of consumers.

Arbitration clauses in existing account contracts blocked Wells fargo customers from bringing group lawsuits for the unauthorized account openings, he said.

“Companies have argued that group lawsuits are unnecessary because the government can pursue enforcement actions to address the same problems,” said Cordray. “But consumers should be able to stand up for themselves and pursue their own legal rights without having to wait on the government.”

According to a study by the CFPB, group lawsuits succeed in bringing hundreds of millions of dollars in relief to millions of consumers each year, and at least 34 million members of group lawsuits received payments totaling $1 billion in cash direct to consumers, net of attorney’s fees and expenses.

Over the two years the CFPB examined final results of the study, in about one thousand arbitration cases, the arbitrators awarded a combined total of about $360,000 in relief to a total of 78 consumers.

During a phone call with reporters, Cordray acknowledged the opposition the rule is likely to face in Congress at a time when lawmakers are already moving ahead with a bill to cut the agency’s power.

Media reports have indicated that U.S. Sen. Tom Cotton, a Republican from Arkansas, started the process for reversing the rule shortly after it was passed.

“I am, of course, aware of those parties who have indicated they will seek to have the Congress nullify this new rule,” Cordray said in a statement. “My obligation as the director of the Consumer Bureau is to act for the protection of consumers and in the public interest. In deciding to issue this rule, that is what I believe I have done.”

New CFPB Arbitration Rule Could Prove Costly For Community Banks

by Bram Berkowitz time to read: 2 min