Most large American banks now offer small-dollar loans to customers, which is something that supporters suggest lessens the need for payday lenders. In 2013, federal regulators derailed previous attempts to make these loans more widespread following media criticism. The Federal Deposit Insurance Corporation changed tactics during the Trump administration when it stated that financial institutions “can play an important role in providing small-dollar loans safely and responsibly.” Those who previously castigated this type of borrowing now see it as a better alternative (and potential replacement) to payday loans. These hopes seem too good to be true given existing political realities.
Pew Charitable Trusts’ Consumer Finance Project characterized the small credit lines/loans last month as if they were a godsend for lower-earning Americans. Alex Horowitz and Gabe Kravitz wrote that, “these loans are safer and more affordable for customers who previously would turn to high-cost payday loans or other alternative financial services, such as auto-title loans and rent-to-own agreements.” They believe the banks are adopting a consumer-friendly policy. Horowitz and Kravita also noted that “Borrowers can access the funds in a few minutes or less, because they are automatically pre-approved or complete a quick application and the proceeds are disbursed into their bank account almost instantly.”
This point of view glosses over multiple hurdles in the banking process. People cannot just walk into a bank and get a credit line. Some banks require potential borrowers be current customers, meet minimum balance requirements, have good credit, and live in certain states. There also may be a delay in people getting cash into their own accounts. These arguments reveal a reflexive bias against payday loans that has existed in policymaking circles.
The antipathy towards payday lenders tends to fall under the consumer protection category. Over a dozen U.S. states enacted annual percentage rate (APR) financing caps mostly around 36% against payday loans. Others outlawed payday lending entirely. Congress may be planning its own entry into the payday loan world after President Joe Biden called for a ban on junk fees in his State of the Union address.
Restriction supporters suggest that while borrowers exit the field, payday loan operators bring in more business and become more efficient. They ignore the fact that these types of restrictions give banks an advantage over payday lenders. This is not price-fixing but federal and state governments playing favorites within an alleged free market.
Chip Baltimore, a Taxpayers Protection Alliance senior fellow and former banking counsel, noted that “A cap on the interest rate a payday lender can charge would make it cheaper for a consumer to utilize the services of a payday lender, thus purportedly increasing demand … However, it also makes it more difficult for a payday lender to be financially sustainable, thereby decreasing supply of payday lenders and payday lending products.” The Illinois Small Loan Association made similar comments about payday loan lender closings during the debate over the state’s new loan restrictions in 2021.
Questions remain on whether the small credit lines touted by Horowitz and Kravitz actually accomplish their stated goals or are just tools to get banks more customers. Baltimore noted that, “Oftentimes, however, the small credit lines are used as loss-leaders to other services that the banks provide that make them additional money, such as checking or savings accounts, credit cards, other loan products … Generically, these small loans are financially not profitable for banks on their own.”
Baltimore points out that these kinds of small credit lines typically don’t result in banking profits. Banks might make $50 a year on a $500 loan, he said, but the cash “doesn’t begin to cover the cost of software, personnel, regulatory compliance, marketing, payment processing.” A 2020 study by consultant group Treliant noted that these small-dollar loans “increase operational risk,” including data breaches and potential service failures.
Anti-payday loan crusaders are either willfully ignoring or so blinded by their rage against lenders that they’re ignoring non-governmental alternatives. These include getting help from families and friends, going to a credit union for a loan, getting an extra job, or working with businesses on some kind of payment plan. Payday loans remain a tool for people to use but perhaps as a last resort instead of a crutch.
What should not happen is the government meddling in what loan options, and at what interest rates, are available to consumers. That gives politicians and bureaucrats the opportunity to play favorites and twist the free market into a fixed market.
Taylor Millard is an investigative reporter at the Taxpayers Protection Alliance.