Federal Reserve Official Sees the Future of Credit: Short-Term Loans
A recently published draft of a staff working paper from Alex Kaufman, an economist at the Federal Reserve, takes a much-needed look at the impact of state regulations on payday loan usage. He finds that, functionally, “payday loans are not one product but many,” and that it is crucial to understand the impact of the different state regulatory approaches before pursuing federal regulation of payday loans.
Kaufman rightly concludes, “The price, size, and duration of payday loans, as well as the manner in which customers use them, varies greatly according to their regulatory environment. As we possibly move toward a regime of federal regulation, it is crucial to better understand how these different types of regulation work.”
Drawing on data from a national payday lender with operations in 26 states and spanning the time between January 2007 and August 2012, Kaufman examines short-term loans in the context of existing state regulations to estimate the impact of various regulatory regimes. He considers the most common regulatory strategies, including restrictions on loan prices, loan amounts and the number of loans a consumer can borrow.
The working paper presents several findings that are particularly interesting in the context of other recent research on payday lending from the Consumer Financial Protection Bureau (CFPB). For instance, in this examination of more than 56 million loans made to nearly 3.5 million customers over almost 6 years, Kaufman calculates an average number of loans of 15.8 per customer (extrapolated to 2.8 loans per year per customer), and a median number of loans per customer of seven over the entire period. This is in stark contrast to the findings of the CFPB in its recent white paper.
Further, this working paper does what the CFPB’s white paper does not: examine the impact of state-level regulations and consumer protections on payday lending before drawing conclusions. More research is undoubtedly needed to understand the relationship between the various regulatory strategies, and to account for the variety of approaches across the states with respect to rollovers, cooling-off periods, and extended payment plans, in particular, which currently make it difficult to compare and contrast their impact. Such research should also consider the role and impact of unregulated, unlicensed lending as it relates to the broader competitive short-term lending market.
As Kaufman notes, research on payday lending up to this point overwhelmingly seeks to address the question of whether payday lending helps or harms consumers – whether the loans are “welfare-enhancing.” Two recent reports examine the consequences of payday lending upon borrowers’ consumer financial health, including their credit scores.
Research from Bhutta, Skiba, and Tobacman finds that consumers apply for short-term loans when their access to mainstream credit options is restricted and that they often also have troubled credit histories. Following a comparison of a national lender’s administrative data with credit bureau files, the authors conclude that payday lending has no long-term effect on borrowers’ credit scores and other measures of financial well-being.
Further research from Bhutta looks at credit record information and data from the U.S. Census and finds that payday loans have no effect on credit scores, new loan delinquencies, or a borrower’s likelihood of overdrawing a credit line, and that neighborhoods’ racial composition does not influence payday lenders’ center locations.
Research such as these studies is essential to the dialogue surrounding short-term credit; it affirms the essential role it plays in American consumer financial services. As Kaufman writes, “it seems likely that payday lending, or something similar to it, will remain a feature of the credit landscape for the foreseeable future.” Given this likelihood, perhaps it is time to ask not whether payday lending is good or bad, but what the merits of short-term lending under different regulatory approaches might be.