It’s time to let the banks compete with payday lenders
(Mark Almond/[email protected])
By James R. Barth and John Jahera
James R. Barth is Eminent Finance Scholar at Auburn University, Senior Fellow at the Milken Institute, and was a federal financial regulator appointed by Presidents Ronald Reagan and George HW Bush. John S. Jahera, Jr. is Bobby Lowder Professor of Finance at Auburn University and is the author of over 80 journal articles.
The arguments about the pros or cons of payday loans have been around since these products first appeared in the US market 25 years ago. Do they offer a benefit or should we ban them altogether?
But this is not the right way to approach the problem. With other consumer products, we don’t limit our choices to a thumbs-up or a thumbs-down. Instead, we design methods to help the product perform while protecting the customer by enacting safety standards where necessary.
With regard to payday loans, this has been the work of the Federal Bureau for Financial Consumer Protection (CFPB). The CFPB will be proposing new rules for this market in the coming months and has already released a preliminary framework of these rules.
But first, to help understand how this industry is currently regulated and how regulation affects the number and location of payday lenders, we’ve assembled a database of laws in the 36 states where payday loans are. offered and the number of payday loan stores by state. This allowed us to analyze the differential impact of state laws on the operations of payday lenders. This research helps shed new light on how consumer warranties affect operations in different states.
Where some states (for example, Montana and New Hampshire) have passed unrealistic interest rate limits – on the order of 36% APR, for example – payday loan shops have disappeared altogether. But surprisingly, when states adopt moderate interest rate limits, as happened in Colorado and Oregon, credit continues to be readily available to consumers.
Surprisingly also, states like Wisconsin, Missouri, and Texas – which allow lenders to charge very high interest rates or operate without rate limits, and where rates can be three to four times higher than in the cheapest states – have the most loan companies and locations. Thus, competition does not seem to drive down prices.
The payday loan industry argues that there’s a good reason its lending rates are so high: Payday lenders are small operators who spend up to two-thirds of their income to run their stores and they have to pass that cost on to customers.
Being more diversified, banks and credit unions do not have this problem; they have already built their branches and are staffing them to provide other services. In fact, the top four banks in the United States have more locations than all the payday lenders in the United States combined. They also don’t have to spend a lot on customer acquisition.
This is why the CFPB has identified the processes by which banks and credit unions can enter the short-term loan market as cheaper alternatives. The CFPB proposal is likely to move the market towards installment loans with smaller payments and make the process less expensive for traditional lenders to provide small loans that would otherwise be unprofitable.
The CFPB framework would allow loans that limit monthly loan payments to an affordable amount of 5% of a borrower’s monthly income and limit the loan term to six months. Banks could issue these loans successfully because underwriting requirements would also be streamlined, i.e. made low cost (although if federal regulators like the Office of the Comptroller of the Currency require banks to underwrite fully, lending a few hundred dollars for a few months will be so expensive that banks would have to charge high prices, like payday lenders).
If banks are allowed to use the CFPB’s simplified procedures, the Pew Charitable Trusts estimates that they could offer loans profitably at prices six times lower than payday lenders. It would put a remarkable amount of money back into the pockets of working Americans, who collectively spend $ 9 billion a year on payday loan fees.
Today, banks primarily serve their living paycheck-to-paycheck customers with overdraft penalty fees that carry even higher annualized rates than payday loans. It doesn’t make sense to allow them to charge $ 35 for a few days of overdraft credit, or $ 70 for two small overdrafts, but not to allow them to charge the same amount for three or four months of installment credit. safer and more user-friendly.
Our research indicates that consumers can take advantage of the small loans available to enable them to meet urgent needs. At the same time, the loans are far too expensive, given that lenders charge four times as much in some states than in others. To preserve access to small installment credit without the exorbitant prices, banks must be allowed to get involved. Consumers will embrace these small, lower-cost loans – regulators should too.