Are Payday Lending Markets Competitive? despite Their Claims, Credit Unions Seem Unable to Offer Competitive Payday Loans
Stango, Victor, Regulation
The rapid and widespread growth of the payday loan market has sparked considerable controversy, in part regarding the "high" prices charged on payday loans. Are such accusations warranted? Payday lenders argue that their loans do not yield excess profits once one accounts for the full economic costs of the business. Banks and credit unions, however, argue that prevailing fees more than cover costs; credit unions in particular argue that they can effectively serve the same borrowers at lower prices.
This article presents several new pieces of evidence addressing the question. Can credit unions provide functionally identical payday loans at a lower price, or offer a different product with a price/characteristic mix that payday borrowers prefer? Considering both prices and non-price characteristics is critical, because even lower-priced credit union payday loans cannot compete with standard payday loans if they have qualitative characteristics that potential borrowers find extremely unattractive, or if they screen potential borrowers out of the market through tighter credit approval requirements.
The most direct evidence is the most telling in this case: very few credit unions currently offer payday loans. Fewer than 6 percent of credit unions offered payday loans as of 2009, and credit unions probably comprise less than 2 percent of the national payday loan market. This "market test" shows that credit unions find entering the payday loan market unattractive. With few regulatory obstacles to offering payday loans, it seems that credit unions cannot compete with a substantively similar product at lower prices.
Those few credit unions that do offer a payday advance product often have total fee and interest charges that are quite close to (or even higher than) standard payday loan fees. Credit union payday loans also have tighter credit requirements, which generate much lower default rates by rationing riskier borrowers out of the market. The upshot is that risk-adjusted prices on credit union payday loans might be no lower than those on standard payday loans.
A final point--one that is too often ignored in policy discussions-is that borrowers find the non-price characteristics of standard payday loans superior to the non-price features of credit union payday loans. Credit unions have locations and business hours that consumers find less convenient than those of commercial payday lenders. Application times are longer at credit unions. And default on a credit union payday loan may harm one's credit score, while default on a standard payday loan does not harm one's credit score. Current payday loan customers view these restrictions negatively, expressing a preference for a less restrictive but higherpriced payday loan over a more restrictive and lower-priced payday loan. Borrowers also dislike the lack of privacy conferred because credit union payday loans do not "keep my payday borrowing separate from my other banking."
In short, the claim that other financial institutions can serve the market at lower prices does not seem justified. At lower rates and fees, credit unions are either deterred outright from offering payday loans or are only willing to offer a type of loan that potential borrowers find unappealing.
Payday Lending: A Primer
A payday loan is a short-term advance against a future paycheck. A payday lender generally advances a customer $100-$500 per loan. In return, the borrower leaves a postdated check with the lender for the loan principal plus fees, and the lender deposits the check after two weeks. The loan fee, which one can view as an interest charge, is typically about $15 per $100 advanced. Payday advances are uncollateralized, like credit cards and unlike home and auto loans. Approval requirements are minimal; a recent bank account statement, a pay stub, and photo identification are often enough for approval. In most cases, the only cause for denial is recent default on a payday loan. …