A blog post published Monday by the New York Fed offered the embattled payday lending industry a rare show of regulatory support.
The post pointed out that payday lenders charge high prices of up to an estimated 391% annual interest charge but also noted that the industry is competitive and profits - when adjusted for risk - are on par with those of other financial firms. A New York Fed official and three academics co-authored the post.
The piece also explains that fees don’t “spiral” - as critics of the industry regularly state - because rollover fees aren't charges and the interest doesn’t compound.
"Perhaps it’s just semantics, but ‘spiraling' suggests exponential growth, whereas fees for the typical $300 loan add up linearly over time,” according to the report.
The article points out that payday loans don’t impact credit scores, a critical point because it means there aren’t new financial problems appearing as a result of using payday lenders. The article further states that payday lenders don’t target minorities but typically locate in lower-income communities, citing ZIP-code-level studies.
The article acknowledges that 20% of new payday loans are rolled over six times, but notes that evidence is mixed on whether users are being fooled by them.
Payday lenders are regularly targeted by regulators for their practices.
President Barack Obama has said the industry traps people in a cycle of debt and the Consumer Financial Protection Bureau in March identified practices it's concerned about, including failure to underwrite for affordable payments, repeatedly rolling over or refinancing loans, holding a security interest in a vehicle as collateral, accessing the consumer’s account for repayment and performing costly withdrawal attempts.
The CFPB's plans for revamping payday lending set off a fierce debate over whether it had gone too far or not far enough, proving that it's likely to be one of the trickiest rulemakings the agency will attempt.
Under a proposal, the CFPB would give lenders two options: either ensure borrowers have the ability to repay before issuing credit or comply with limitations after the loan is issued such as restricting how often it can be rolled over or reissued within a certain time frame.
Industry representatives declared that the CFPB's plan was too broad and would cut off access to small-dollar credit. Consumer groups said there are too many "loopholes" for lenders to exploit.