Is it time to further regulate the payday lending business?

I've been working closely for a couple of years now on the regulation of Canadian financial institutions and financial markets. However, I learned a few things recently when I attended a panel on payday lending. A payday loan in Alberta is a short-term loan of up to two months to a maximum amount of $1500.  These lenders can charge up to $23 per $100 borrowed. 

First, I learned that "underbanked" is a word in some circles. In essence it means that some geographic areas, or population groups, are underserved by traditional banks. As you might guess, those earning this new-to-me adjective are at the margins of our economy. They work, but their job does not pay enough to survive a sudden change in circumstance. 

Another important thing I learned was that the regulation of those providing payday loans is far removed from all of the traditional lenders my research program has been studying for years. They skirt the section of the criminal code that limits annualized interest rates in Alberta to 60% (!) because they quote their charges in dollar amounts instead of percentages. They are exempt in some cases from disclosing their charges in the usual Annualized percentage Rate (APR) that became the standard in North America in the 1970s and 80s when mortgage regulations were standardized. 

These working poor are attracted to payday loans because of their convenience, which reflects the reality of banks’ limited presence in some neighbourhoods, but also the fact that they involve less time and paperwork.  Most truly believe they will be able to pay the loan back with their next paycheque.  But, as life has a way of throwing surprises at us, many get locked into a vicious cycle of reinstating the loan over and over again, often adding the fees on top of the original loan amount.  When one does the math, a $300 loan taken for 14 days at the maximum fee results in an APR of about 600%.  Even most of us with middle incomes and higher would have difficulty escaping debt if we were being charged interest at that rate. While these annualized rates seem shocking, they also reflect some of the challenges faced in this market – challenges that some financial institutions are working to try and overcome. 

Small loans of short duration, in addition to the obviously high administration cost of a small loan, exhibit a high risk of default.  Pawn shops used to be traditional lenders as well but you need pawnable collateral for that option.  If we go too far in limiting legal lending practices, we may see the emergence of illegal ‘loan sharks.’  The question is not a simple one.

Economists would argue that if this market is competitive then whatever fees are being charged are likely the lowest that the market can provide.  As it stands now, however, we have no way to determine if these charges are the best we can expect for the underbanked borrowers.  We can, however, observe that the markets continue to function in other jurisdictions with lower maximum charges, e.g., Manitoba’s $17 per $100.

Similarly we have no guarantees that changes in the system of regulation can improve the lot of those in this market.  However, as we strive toward equity and transparency in Canadian public policy, the very least that should be done in the consultation underway by the provincial government is to require disclosure of the borrowers’ charges in a way that permits ‘apples to apples’ comparison.  Proposals, such as those seeking to reduce the maximum fee allowed in Alberta, create a financial literacy fund, and mandate a payment plan option for those unable to repay the loan in full, are worthy of consideration by those more knowledgeable than I.  Constraining exploitive practices in the market may be in order, however, as the Notley government is busy preparing its poverty reduction strategy.   As part of that process, I recommend that another lens also be applied – that of comparing how the regulation of the payday lender compares with that of other lenders.  I find absolutely no rationale for requiring less disclosure and less capital backing promises made to the working poor, many of whom could be the least sophisticated among us – and the most vulnerable.  If anything they deserve more protection, not less.