As payday lenders and check-cashing stores continue to feel the wrath of government regulation, it’s important to understand why they exist in the first place.
On March 7, Prop S was added to the municipal primaries ballot, seeking to punish evil payday lenders in St. Louis by imposing a meager $5,000 annual fee for new and renewal permits for “short-term loan” establishments.
Over the years, as state governments pile regulations on (or outright prohibit) short-term lenders, Missouri, along with a handful of other states with virtually no restrictions, have turned into somewhat of a safe haven for these shops. As a result, consumer advocacy groups in Missouri are trying to curb the alleged “predatory behavior” we all hear about in the news.
Interestingly, we can link increased financial regulation (and, admittedly, de-regulation) to the rise of payday lending.
A brief history lesson
Let’s blow away some cobwebs. In the 1990s, check-cashing stores started offering the option to take out a short-term loan for out-of-the-blue expenses. These payday loans of $100 to $500 are paid back within two weeks or by the borrower’s next payday. The fees for these loans vary from $10 to $25 per $100 borrowed.
The late ’90s also marks the beginning of the end of small community banks. The Glass-Steagall Act, which kept commercial banks from meddling in the investment business, was repealed. Banks could now merge with investment banks and engage in more profitable activities, allowing their balance sheets to balloon. As banks became larger, so did the regulatory regime, e.g. Dodd-Frank. However, smaller banks couldn’t afford to comply with these regulations, so they were either bought out or pushed out of the market.
Traditionally, strong relationships with the depositor was at the core of a community bank’s business. Taking out loans, depositing, paying bills and other services were all done by going into the bank — and usually with your favorite banker. Today, that customer-banker relationship is gone as ATMs and online banking have overwhelmingly taken its place.
Making sense of using payday loans
Lisa Servon, a professor of city planning at the University of Pennsylvania, points out in her new book “The Unbanking of America” how payday lending actually fills the void this transition to big banking has created. As she read the studies placing payday lenders in a negative light, she decided to gather her own data. She worked as a teller at a couple check-cashing stores and interviewed a bunch of the borrowers.
Throughout her time working at RiteAid, she found that the notion that poor people are making poor choices with their money is wrong. It’s simply more costly for poor people to do business with banks than with the alternatives. With many in America living paycheck-to-paycheck, banks can’t clear the check fast enough, even with online banking. Hidden overdraft fees are more detrimental than the upfront fees at the payday store, and ATMs often only dispense money in high denominations.
Many do have credit cards with lower interest rates that are not maxed out, yet still they choose to use a payday loan. But because going delinquent on the payday loan is not reported to the credit bureaus in the same way as credit cards, they choose to preserve their credit score. What’s more is that despite wrapping these lenders in red tape, mainstream quick-dollar loan options are few and far between.
She also noticed that numerous customers would come back, with an improved financial state and a new savings and checking account. Sometimes, they would even leave her a tip. Strong relationships not only help with financial health, but it is appreciated — the banking industry has lost its touch.
Certainly, there are cases of payday lending trapping poor customers in debt with rollover fees and high interest rates. But, regulations favoring the big banks are also culpable. The banks’ hidden overdraft fees and impersonalism have increased the demand for the clear, personal, and convenient service only found at the check-cashing store.
Importantly, being financially strapped does not equate to making bad choices. Further limiting access to payday loans through heavy regulations can undermine the sound decisions being made by many of these borrowers. Expensive credit is better than no credit at all.
Previously posted at GenFKD.