There are few legal industries with a worse public reputation than payday lending.
The whole sector gets an atrocious rap — in the United States, voters overwhelmingly believe that payday lenders have predatory tendencies. Polling in the UK shows that policymakers have dramatically more negative perceptions of the lenders than their actual users do.
But the authors of a new blog post at the New York Federal Reserve’s “Liberty Street Economics” are much more sceptical that the industry’s bad reputation matches up to the evidence.
In short, they conclude that “we can’t be sure that reform will do more good than harm,” based on the existing evidence. Here’s why.
Firstly, the authors note that well-intentioned attempts to cap the interest rates charged by payday lenders can result in driving them out of existence altogether. That’s fine, if it was the intention of the cap. But if your aim was to simply limit their reach, then that’s not good news.
In theory, there’s nothing wrong with payday loans — interest rates are high because the lending isn’t secured against anything and few credit checks are undertaken. It could be a useful mechanism for people to smooth the difficult period running up to payday during particularly tight months.
So a lot of the post focuses on rollovers — when the customer borrows again to pay off their existing debt — and whether that creates a “spiral” in which the repayment becomes impossible. Here’s their evidence on that:
Researchers have only begun to investigate the cause of rollovers, and the evidence thus far is mixed. This study found that counseling prospective borrowers about how the cost of rollovers add up reduced their demand by 11 per cent over the subsequent four months. Their finding suggests “cognitive bias” among some customers and implies that capping rollovers might benefit such borrowers (although the authors themselves did not advocate limiting rollovers). By contrast, this more recent study found that the majority of borrowers (61 per cent) accurately predicted within two weeks when they would be debt-free. Importantly, the study reported that borrowers who erred were not systematically overoptimistic; underestimates of borrowing terms roughly balanced overestimates. After reviewing the available evidence, one expert in behavioural economics concluded that the link between overoptimism and overborrowing (that is, rollovers) “. . . is tenuous at best, and arguably non-existent.”
They highlight how much more research into payday lending is required — based on what exists right now, it’s not at all clear that changing the way payday lending works is a good idea.