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Why Payday Loans are Good for Millions of People

The Justice Department and state regulators are targeting banks that service a broad range of what they consider questionable financial ventures, including some online payday lenders. I applaud the government's efforts to weed out bad actors that engage in fraudulent transactions or violate federal laws. But I'm deeply concerned about the unintended consequences this could have on much needed financial services for underbanked people who rely on legitimate short-term lenders, commonly referred to as payday lenders.

Payday lending is pretty simple. An individual has an urgent short-term need for cash and goes to a payday lender. A person with a job, a checking account and proper identification can borrow anywhere from $100 to $500 until his or her next payday. Such borrowers write post-dated checks or provide written authorizations to the payday lender for the amount of the loan plus a fee, which is typically 15%. On the next payday the loan is either repaid in person by the borrower or the lender cashes the check or initiates an electronic funds transfer. That's it.

The typical first-time payday transaction is completed within 15 minutes. Very few banks are willing to make these loans the transaction costs are simply too high.

Millions of middle-income Americans live paycheck to paycheck. They do their best to manage their finances so that all their obligations are met. But when something unexpected crops up, such as a blown transmission, an unexpected doctor's bill or a badly needed roof repair, their financial schedules are thrown off and the need for short-term credit may arise.

Some turn to relatives or friends for help in a crunch. But many may face the Hobson's choice of deciding between having their electricity turned off, their car repossessed, their job lost, their rent or mortgage unpaid or their check bounced. Payday lenders offer a better way out.

Critics of payday lending cite the high interest rates they charge. A $15 fee on a $100 advance for two weeks amounts to a 391% annual percentage rate, or APR. That's high when expressed as an annual rate, but keep in mind that the typical term of these loans is a couple of weeks. It's also notable that the annualized interest rate on the average payday loans is much lower than it would be for the fee on a bounced check or a late mortgage or credit card payment.

The $15 cost of a $100 payday loan also pales in comparison with the lost income when a car is out of commission and a job lost. Good payday lenders clearly disclose their loan terms and conditions, including the dollar amount of any fees and the APR. Moreover, payday lenders are regulated and supervised by state agencies and also the new federal Consumer Financial Protection Bureau. My firm has worked with payday lenders to get them into compliance with regulations applicable to banks.

Some online lenders avoid regulation by setting up operations offshore or on an Indian reservation outside the reach of regulators. I applaud the regulators for attempting to shut down such operations by denying them access to the banking system.

But I also caution about the potentially unintended consequences of driving all payday lenders away from banks. This is the last thing we need at a time when the economy is languishing, in significant part because only the most creditworthy can qualify for a bank loan.

At this point, banks would be well advised to conduct proper due diligence on their payday lending customers to determine whether they are following state and federal laws, have established written regulatory compliance and anti-money laundering programs, follow trade association best practices and obtain from valid customer authorizations for automatic funds transfers. If a payday lender cannot answer these questions affirmatively, the bank is likely working with the wrong customer.

Some argue that payday loan portfolios have enormous losses imbedded in them because the loans are never really repaid just rolled over and over again. But most states limit the number of rollovers, and most payday lenders impose similar limits, even in the absence of state laws.

The risks of payday lending are ameliorated due to the enormous diversification in the portfolios, and risks are priced into the fees. It's feasible for a reputable and efficient payday lender to maintain high loan loss reserves and substantial capital against payday loans and still achieve decent returns.

The regulators would do well to examine the welfare of borrowers in a variety of regulatory settings before they act in a way that might endanger the very people they are trying to protect the underbanked. The truth is that millions of customers have a very favorable experience with the short-term lending product, and we should be careful not to disrupt this important lifeline.

William Isaac, a former chairman of the Federal Deposit Insurance Corp., is the global head of financial institutions for FTI Consulting, which has worked for payday lenders, and the chairman of Fifth Third Bancorp. The views expressed are his own.


(10) Comments



Comments (10)
This is an excellent read William! I've never agreed when payday loans get a bad rep. A borrower is getting money in a pinch when they have little or no credit and they have no other options. It's an extremely high risk for the lender, therefore there's high APR. I personally advise people to use because they work with a network of over 100 lenders.

Payday loans can save people from foreclosure, financial emergencies, and so much more. Obviously they're only intended for short term financial needs, not a long term plan. Bottom line, it's a good option to have when times are tough.
Posted by Janet_finacial | Thursday, February 18 2016 at 4:47PM ET
Mr. Isaac and Frex,

Help for consumers is on the way in the form of high-tech "virtual wallets" that enable the unbanked and sub-prime borrowers to access their payroll proceeds immediately (24/7) send money to friends and family free, access cash at ATM's for very minimal fees (IE: $50 for $1.00), pay any vendor (electric, water, gas, phone...) free and get a small dollar loan. Granted, the small dollar loan fees are still in 400%+ APR range but this will change very soon!

The virtual wallet solution taking the small dollar loan space by storm today allows 1 wallet - 1 consumer - 1 lender; almost like a state data base (refer to Florida as but one example.)

Fees charged to consumers are headed down. The associated costs for originating and funding a small dollar loan are beginning to fall.

And all without the aid of ACH (Automated Clearing House), regulators or so-called consumer advocates.

We're talking Live 24/7 $$ delivery. No batching. No 2 - 4 wait for the merchant or the consumer to receive the funds. It's here, NOW.
Posted by Jer - Trihouse Consulting | Friday, September 06 2013 at 4:17PM ET
That's not technically a "correction." That's you using the word "correction" to reassert authority rhetorically. In order to be corrected, I'd have to be wrong. If you did work for payday lenders, they paid you directly. What's wrong with that assertion, exactly?

Here's a real correction: There are 7,598 credit unions in the United States of America. There are currently 23,417 payday lenders--including payday lenders masquerading as credit unions, meaning there's actually an overlap in the credit union category. I don't know whether this means you don't know your own industry, or if you're just plain lying to make yourself look more "right" than I am. Either way, it's not really working.

On a final note: I'm a chair on an organization that is working diligently on getting the aforementioned legislative agenda enacted. I can only assume you somehow knew this and were genuinely wishing me luck in my endeavor, for which I am grateful. Because after all, if you hadn't known that this was the exact nature of my work, that would make you petty and sarcastic, on top of being either incompetent or a liar. And I'd never suspect you of any of that.

Anyhow, good day, Mr. Isaac. I sincerely hope you never find yourself needing a payday loan; I wouldn't wish one of those on anybody.
Posted by frex | Thursday, September 05 2013 at 11:56AM ET
Thank you, frex. In the meantime, while you are working on getting your legislative agenda enacted, some of which I believe could be helpful, tens of millions of people rely on payday lending and consider it the best available alternative.

There are already more credit unions, which are subsized by taxpayers, than payday lenders. If they were an effective alternative for people who need short-term, unsecured loans there would not be a payday lending industry or at least it would be much smaller.

One last comment to correct your assertion that my income "is tied directly to the proliferation of payday lenders." In the interest of full disclosure, I noted in my byline that my firm has done some work for payday lenders, which is why I have more than passing knowledge of the industry. That work was minor in the scheme of things, and it was directed at helping payday lenders comply with bank-type regulations.

Bill Isaac, former FDIC Chairman
Posted by billisaac | Thursday, September 05 2013 at 7:19AM ET
Of course! Society has never come up with a better idea for "helping" the poor other than "burying them in an infinitely deepening ditch of debt that they're designed to never recover from." Nobody's ever once proposed any of the following:

1. Increasing minimum wage

2. Providing lenders with tax benefits that offset the transaction fees of short term loans so the brunt of the costs aren't shouldered by the poor

3. Legislation empowering and protecting small, neighborhood credit unions so that they're easier to start up and can more readily provide REAL competition to payday lenders with terms like multiple installment payment plans, no unnecessarily coercive security stipulations and no mandatory arbitration clauses

4. A 36% APR cap and minimum 90 day length for current short-term lending industry-wide

5. Better consumer education about existing alternatives like BillFloat and LendUp

6. Expanding local financial hardship relief programs for working poor families

...and the list goes on and on and on. But you're not interested in these alternatives. Why would you be? Your income is tied directly to the proliferation of payday lenders, as your byline bio indicates. You simply wanted to "prove" that I had no idea what I was talking about, so you could appear to be "right" be default and "win" some Internet argument. My alternatives might not be perfect; I'll grant you that, but they're better for consumers than payday loans. And they're certainly better than high-school debate team rhetorical tricks.
Posted by frex | Thursday, September 05 2013 at 12:55AM ET
I gather that the answer to my question, frex, is that you have no ideas on alternatives for improving the provision of short-term, unsecured loans to the tens of millions of people who need them.

Bill Isaac, former Chairman FDIC
Posted by billisaac | Wednesday, September 04 2013 at 6:32AM ET
You quoted me as having used the words "absolute last resort," then stated that this affirms that tens of millions of people view this as "the best alternative available." One of the problems with explaining the "alternatives" to someone who makes rhetorical arguments like that is you can't even comprehend the reality that the working poor in this country live in. I say this confidently, because you displayed a failure to comprehend basic logical reasoning.

The other problem, of course, is that "increased competition" would have to come in the forms of quality-of-life improving programs and laws--precisely the kinds of legislation the payday lending and banking industries at large work dutifully to prevent. Because so far, there are 31 states with more payday lenders than McDonalds restaurants; and the costs to customers are still astronomical. The existing lenders aren't competing; they're colluding.
Posted by frex | Wednesday, September 04 2013 at 12:27AM ET
Do you have an alternative, frex? Pawn shop? Loan shark?

You state "Even the 45 million working poor in this country who all at some point are forced to stare down the barrel of a payday loan know that they do so as an absolute last resort that will come back to bite them." While a bit flamboyant, your words affirm that tens of millions of people each day view a payday loan as the best alternative available to them.

Good public policy would acknowledge the incredible demand for short-term, unsecured lending and would encourage reputable, regulated financial institutions to meet this need. While this will always be a relatively expensive way to borrow money --because transaction costs and default rates are high and there is no collateral backing the loan -- increased competition will drive the price down substantially.

Bill Isaac, former Chairman FDIC
Posted by billisaac | Tuesday, September 03 2013 at 3:35PM ET
I suppose calling a blog article written by a wealthy chairman in the pocket of payday lenders to be "out of touch" on the matter would be a bit pointless.

Still, no matter how hard this article is trying to convince readers that payday loans are a helpful tool that the faceless, voiceless poor benefit greatly from, understand that nobody in their right mind thinks they're a good idea. Even the 45 million working poor in this country who all at some point are forced to stare down the barrel of a payday loan know that they do so as an absolute last resort that will come back to bite them. And bite down hard.

Yes, it's 15.5 percent APR for a payday loan. Unless you can't pay in 14 days (spoiler alert: you can't.) Then, your loan is extended to 180 days, at an average of 403.1% APR. The $500 dollars you borrowed because you couldn't afford to wait for your paycheck just turned into $1,275 that you definitely can't afford, because people like the author of this article pay a great deal of money to lobbyists who keep your minimum wage rates far, far beneath the poverty line.
Posted by frex | Tuesday, September 03 2013 at 2:54PM ET
Since 1997, I've been a payday loan lender and industry consultant. The PDL industry has changed dramatically. The "bad guys": those who abused consumers, failed to clearly disclose rates/fees/contact info, indiscriminately employed the ACH system to intimidate borrowers... are leaving in droves. Add to this the implementation of big data strategies and social media activity monitoring for underwriting algorithms, in conjunction with virtual wallet $$ delivery systems, and you have a "perfect storm" resulting in a multitude of benefits to the 60M U.S. consumers who want these products. The future for both borrowers and lenders looks very bright! I'm long...
Posted by Jer - Trihouse Consulting | Friday, August 16 2013 at 7:18PM ET
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