California lawmakers are considering a bill that could potentially cripple profits for payday lenders in the nation's largest state.

Modeled after laws in Delaware and Washington state, the measure would bar consumers from taking out more than four payday loans in a 12-month period. It is being pushed by consumer advocates, whose efforts to impose a 36% interest-rate cap on short-term loans in California have long been stymied.

The bill, which will get its first legislative hearing Wednesday, "takes a dramatically different approach from previous efforts to reform payday lending by targeting the highly toxic aspects of these loans," the Center for Responsible Lending said in a statement.

Californians borrowed $3.3 billion from payday lenders in 2011, according to a state report. That figure accounts for more than 40% of the estimated payday borrowing nationally.

Payday customers in California borrow an average of seven times per year. Consumer groups argue that although the industry touts payday loans as way for people to get cash for unexpected expenses, it actually relies on consumers who get trapped in a cycle of debt.

Under the proposed law, a real-time database would be created to ensure that payday lenders know not to lend to customers who've already hit the annual cap.

"Payday loans would still be available, but used much more narrowly," says Paul Leonard, director of the Center for Responsible Lending's California office.

The experience in Washington state suggests that restrictions on the number of transactions Californians can make in a year would hit the payday lending industry hard. Loan volume in Washington fell by 75% after the state enacted a limit of eight payday loans per year, according to the California bill's supporters.

Payday lenders say the California bill would simply drive consumers who need short-term credit to unlicensed providers online. Many of those companies are based offshore, which may allow them to evade U.S. law enforcement.

"The reality is, if there product were to go away, the demand for short-term credit surely will not. And they will have to turn someplace else. And they may have to turn to the unlicensed, unregulated Internet," says Greg Larsen, spokesman for the California Financial Service Providers Association, which represents licensed payday lenders.

Referring to the vulnerability of borrowers to unlicensed lenders, Larsen adds: "What are the implications for their financial security? What types of onerous collection practices are they going to face?"

The legislative debate in Sacramento comes at a time when California officials are trying to crack down on unlicensed Internet lenders.

On Monday, California regulators issued a press release publicizing a recent enforcement order against Northway Financial Corp., an unlicensed lender based in Malta that makes loans at The offshore company faces citations totaling $32,500.

Since January, California has sanctioned other unlicensed payday lenders based in Costa Rica, Belize and the United Kingdom.

State officials will not say whether they've been able to recover any money from offshore companies, but they readily acknowledge the challenges involved.

"The biggest obstacle facing our enforcement team in pursuing unlicensed online lenders is that most do not have physical locations and, if they do, the location may be out of reach of federal and state authorities," Jan Lynn Owen, commissioner of the California Department of Corporations, said in testimony last month.

These unlicensed Internet lenders appear to represent a growing part of the payday loan market, but there is no comprehensive data on their size, in large part because companies are operating without state licenses.

"It's hard to tell how large a problem it is because they are working off the books, off the radar, and they're doing it purposely," says Mark Leyes, spokesman for the California Department of Corporations.

Consumer advocates say the solution to unlicensed lending is better enforcement, drawing on the resources of the federal government and the states, rather than looser restrictions on licensed lenders.

"The idea that is often asserted that we have to deregulate the regulated marketplace in order to compete with an unregulated Internet marketplace is not one we subscribe to," says the Center for Responsible Lending's Leonard.

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