I can’t wait to see what they come up with.
Whenever governments start thinking about cracking down on small-dollar, high-interest financial products like payday loans and check cashing services, a shrill cry goes up from the businesses that offer them: You’re just going to hurt the poor folks who need the money! What do you want them to do, start bouncing checks?
A field hearing held by the Consumer Financial Protection Bureau today was no exception. The young agency has been studying how the industry functions for a couple years and is now very close to issuing new rules to govern it. To start setting the scene, CFPB Director Richard Cordray came to Nashville — the locus of intense payday lending activity recently — to release a report and take testimony from the public.
The report, building on a previous white paper, is fairly damning: It makes the case that “short term” loans are usually not short term at all, but more often renewed again and again as consumers dig themselves into deeper sinkholes of debt. Half of all loans, for example, come as part of sequences of 10 or more renewed loans — and in one out of five loans, borrowers end up paying more in fees than the initial amount they borrowed.
Passing a rate cap, however, is not the only remedy. In fact, it’s not even possible: The CFPB is barred by statute from doing so.* And actually, the Pew Charitable Trusts — which has been tracking payday lending for years — doesn’t even think it’s the best approach.
“The core problem here is this lump-sum payday loan that takes 36 percent of their paycheck,” says Pew’s Nick Bourke, referring to the average $430 loan size. “The policy response now has to be either eliminate that product altogether, or require it to be a more affordable installment loans.”
Bourke favors the latter option: Require lenders to take into account a borrower’s ability to repay the loan over a longer period of time, with monthly payments not to exceed 5 percent of a customer’s income. That, along with other fixes like making sure that fees are assessed across the life of the loan rather than up front, would decrease the likelihood that borrowers would need to take out new loans just to pay off the old ones.
See here for the background. It’s fine by me if the CFPB takes a different approach than usury caps. States and localities can still do that themselves if they wish, with the CFPB’s rules serving as a regulatory floor. It’s a step forward any way you look at it, with the potential to do a lot more if needed.
Now, the installment loan plan wouldn’t leave the industry untouched. When Colorado mandated something similar, Pew found that half of the storefront payday lenders closed up shop. But actual lending didn’t decrease that much, since most people found alternative locations. That illustrates a really important point about the small dollar loan industry: As a Fed study last year showed, barriers to entry have been so low that new shops have flooded the market, scraping by issuing an average of 15 loans per day. They have to charge high interest rates because they have to maintain the high fixed costs of brick and mortar locations — according to Pew, 60 percent of their revenue goes into overhead, and only 16 percent to profit (still quite a healthy margin). If they were forced to consolidate, they could offer safer products and still make tons of money.
Meanwhile, there’s another player in the mix here: Regular banks, which got out of the payday lending business a few months ago in response to guidance from other regulators. With the benefits of diversification and scale, they’re able to offer small-dollar loans at lower rates, and so are better equipped to compete in the market under whatever conditions the CFPB might impose.
Actually, there are two other potential players here as well: Post offices and WalMart stores, both of which could do a lot to streamline this industry by aggressively competing on price. If that happens to drive a lot of small, inefficient players out of the market, too bad for them. These options would unfortunately require an act of Congress to become reality, and the odds of that are vanishingly small. But the point is that those options exist, and if the regs that the CFPB does put forth winds up squeezing a lot of the existing players, the demand will be there for bigger dogs to come in. In most cases that would be bad, but this is the exception. We’ll see how it goes. And whatever does eventually happen, let’s not forget that if we had less poverty, we’d have less demand for payday lending. Consider that yet another argument for raising the minimum wage.