Payday Lending Needs Transparency, Not Annihilation
Let's stop talking about what we don't like and start having more productive discussions on how elected representatives, regulators, consumer groups and industry leaders can work together to foster innovation in the short-term credit market that leads to better products for the nation's consumers.
Bankers are mulling new ways to serve consumers with low incomes and poor credit profiles after the crackdown on deposit advances, but the prospect of smaller profits and continuing uncertainty about regulations may dissuade a serious effort.
Payday lenders have often been called predatory, yet many financial services firms will acknowledge these lenders serve many of their customers and members. Why?
Paycheck-to-paycheck cash need is a reality for more Americans than one would think. About 40 to 50 million Americans are highly illiquid. Payday lenders are participants in the financial service marketplace because they fill the demand for short-term, unsecured loans that traditional financial service providers avoid making. This demand is powered by the small-cash market, which includes the unbanked, underbanked and/or people with credit scores below 600.
There are 2,697 payday lenders offering payday loans in 36 states at 12,405 locations and employing over 50,000 people. This is about the same number of workers in two other important U.S. industries: logging and water transportation. Over half of these payday lending outfits are single-location, family-owned outlets, run 24/7.
Payday lenders charge a smaller amount for their loans than depositories charge on overdrafts. Payday loans are either traditional $18 fee per $100 for 14 days or are installment loans at $20 per $100 for up to 180 days or six months. A depository charges an overdraft fee overnight of $30 per transaction on average.
A 2008 Government Accountability Office study of overdrafts and a subsequent Federal Deposit Insurance Corp. overdraft study both show the median amount of a consumer short fall between paychecks is $40. Many short-term credit users know the low-price way to cover these types of short falls is with a payday loan.
Truth-in-lending formulas for calculating the annual percentage rate for payday loans are meaningless to the payday borrower. Using APR to report the pricing of small loans or overdrafts is like using a grandfather clock to time a sprinter.
Using a clear disclosure of fees rather than an APR gives a better picture of out-of-pocket costs associated with the loans to the cash-thirsty borrower. The useless APR only gives the payday loan, borrower and lender a stigma.
Transparency and clarity along with speed of communication are essential in the small-cash market, no matter who the lender is. The top ten payday lenders by loan volume do use fee disclosures to comply with Regulation Z and truth-in-lending laws. The remaining 2,000-plus lenders, which are mostly "ma-and-pa shops," are doing their best. Most are citing Reg Z to disclose fees, but some are not. Smaller payday lenders may use, if any, a Federal Reserve standardized form, which is not particularly user-friendly and can be difficult for the borrower to understand.
All payday lenders should move towards greater transparency of fees. Standardization of disclosure is necessary for all payday loans. Currently large and small payday lenders have different forms. Adherence to Reg Z and truth-in-lending laws is a necessity.
As the Consumer Financial Protection Bureau moves to finalize its payday lending laws, it can impose fines to encourage uniform disclosures. This uniformity should address formatting, word choice and the speed in which lenders are required to get information to the borrower. For instance, the CFPB could mandate its standardized disclosures be provided upon application or at least before the loan is originated.
Eliminating payday lenders would create a void that banks, thrifts and credit unions cannot or are reluctant to fill. The cash needs of 22 million people will not go away by eliminating one of the providers of cash. The goal must be finding viable information solutions that are price efficient and user-friendly to borrowers. With greater transparency, payday lenders can become a viable partner in the small-cash market.
G. Michael Moebs is an economist and CEO of Moebs Services.