On the New York Federal Reserve’s blog, four economists recently examined several entrenched yet misguided criticisms of payday lending and found, “many elements of the payday lending critique—their ‘unconscionable’ and ‘spiraling’ fees and their ‘targeting’ of minorities—don’t hold up under scrutiny and the weight of evidence.”
The article calls for further research into rollovers, which are at the heart of the CFPB’s proposed rules, before the Bureau seeks to unilaterally modify or abolish the entire industry.
“After reviewing the limited and mixed evidence on that point,” the economists wrote, “we conclude that more research on the causes and consequences of rollovers should come before any wholesale reforms of payday credit.”
Here are five key issues – and the economists’ response:
On APR, Price and Competition:
“Payday lending is very competitive” [emphasis theirs]
- “An FDIC study using payday store-level data concluded ‘that fixed operating costs and loan loss rates do justify a large part of the high APRs charged.’”
- “And of course, payday lenders also have to compete against other small dollar lenders, including overdraft credit providers (credit unions and banks) and pawnshops.”
On a 36% rate cap:
“A 36 percent cap as an outright ban.”
- “If payday lenders earn normal profits when they charge $15 per $100 per two weeks, as the evidence suggests, they must surely lose money at $1.38 per $100 (equivalent to a 36 percent APR.)”
On compounding fees:
“Fees for the typical $300 loan add up linearly over time”
- “Payday lenders do not charge refinancing/rollover fees, as with mortgages, and the interest doesn’t compound (unless of course she takes out a new loan to pay interest on the first loan).”
On customer base:
“The fact is that only people who are having financial problems and can’t borrow from mainstream lenders demand payday credit, so payday lenders locate where such people live or work.”
- “Are lenders locating in these areas because of their racial composition or because of their financial characteristics? The evidence suggests the latter.”
“Unfortunately, researchers have only begun to investigate the cause of rollovers, and the evidence thus far is mixed.”
- “While rollover caps might benefit the minority of borrowers prone to behavioral problems, what will it cost the majority of “classical” borrowers who fully expected to rollover their loans but can’t because of a cap?”
Previous studies from the Federal Reserve have examined how consumers fare when access to payday loans is restricted, and have underscored the need for more research into state regulatory frameworks before federal regulations are implemented.
- The Federal Reserve Bank of Kansas City found that restricting payday lending can adversely affect consumers, and that payday loans are a cost-competitive option.
- A Federal Reserve Bank of New York staff study found, in Georgia and North Carolina, which effectively banned payday loans through rate caps, consumers “bounced more checks, complained more about lenders and debt collectors, and have filed for Chapter 7 (“no asset”) bankruptcy at a higher rate.”
- Federal Reserve Board economist Alex Kaufman, in examining data from a national lender spanning January 2007 to August 2012, calls for more research into how state regulatory frameworks affect lending markets. “As we possibly move toward a regime of federal regulation,” Kaufman wrote, “it is crucial to better understand how [states’] different types of regulation work.”