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Payday Rulemaking: Is Too Much Competition a Bad Thing?

posted by Adam Levitin

The CFPB's proposed payday rule making is out.  There's a nice summary here.  

I'm going to reserve comment other than to note a critical implication of a rare area of agreement between the supporters and opponents of the payday rule:  it will result in a lot of payday lenders closing up shop.  That might be just what the industry needs.

Payday lending differs materially from bank lending in (among things) that there are very low barriers to entry.  Bank regulators restrict the number of bank charters in order to reduce interbank competition. (What was that about free markets, Jamie Dimon?) That mode of regulation does not exist in payday, and it results in a self-cannibalization of the industry. Most storefront lenders have very few actual customers--a few hundred per store per year. Often stores average less than one customer per day (offset only partially by the fact that these customers tend to take out multiple loans). That means that payday lenders have to amortize their fixed and semi-fixed costs over a small borrower base, which in turn results in very high priced loans even without outsized profit margins. (This also suggests that bank payday lending, like Postal payday proposals, is economically more feasible because of a broader base over which to spread fixed costs.) In other words, too much competition is actually pushing up prices.  

The situation is somewhat analogous to a population of deer (or wolves) that grows too large for the sustenance base.  The resulting overgrazing (or overpredation) can ultimately result in a catastrophic collapse.  The typical wildlife husbandry solution is to cull the herd in order to ensure that the survivors are stronger and healthier.  Regulations that have the effect of reducing the number of lenders can be thought of as functioning in a similar way. In banking, this is done through control over chartering. Insurance does this through rate regulation (preventing destructive rate races). The CFPB's rulemaking is likely to achieve something similar in payday lending. 

We've seen this happen before. In 2010 Colorado undertook a major regulation of its in-state payday industry (this after an unsuccessful round of regulation in 2007). Pew has nicely analyzed the results.  The result of the regulation was that the number of in-state payday lenders fell by half (-53%).  Demand slackened only a little (-7%; why would it disappear?), however, so the number of customers per storefront almost doubled (up 99%).  The terms borrowers received were much better under the Colorado reform, and the revenue per store increased (+26%).  

What the Colorado experience suggests is that it's possible to have both better loan terms for consumers, and a healthier payday lending industry, but only if there is a contraction in the number of lenders. Put another way, some lenders have to go out of business in order for others to do better and for consumers to get better terms. It's rather counterintuitive--normally we think of competition as an important force for consumer protection, but at a certain point, it seems, too much competition actually results in price increases.  But it goes to show that the free market may not always produce the socially efficient result. (Obviously this isn't Pareto efficient, but it could well be Kaldor-Hicks efficient.) Curious to hear thoughts. 



The difference of course is that in Colorado the payday product improved because of the state's new usury cap. Prices went down by statute. For the CFPB's proposal, to make sure borrowers can repay their loans, lenders can either charge less or lend less and keep prices the same. It seems like the latter will be more popular. I think prices might go up because the cost of complying with the regs will drive small lenders out of the market, like it has done in Colorado, leaving big lenders who are more likely to charge high prices and target minorities. At least, that is my guess based on this analysis: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2656683

While the number of payday lenders dropped after Colorado's 2010 law was passed, the number had actually peaked in 2006 and started falling in mid 2008. The 2010 law doesn't appear to have affected the rate of closures. See page 3 of http://coag.gov/sites/default/files/contentuploads/cp/ConsumerCreditUnit/UCCC/AnnualReportComposites/DemoStatsInfo/ddlasummary2000-2012.pdf

The "contract store numbers and generate economies of scale" ignores that payday customers consistently value convenience above all else-that's why PD lenders outnumber Starbucks. The distance between stores after CO. reform must have increased markedly so now the poor souls who need PD credit spend more time in Denver traffic driving to make their payment. Without factoring that in, the welfare effects of the reform are uncertain.

"Regulators restrict the number of bank charters to limit interbank competition." Really? I've heard avoiding "ruinous competition" as argument why interstate banking was limited but I've never heard it in modern times. Imagine the hue and cry if OCC refused a charter to protect incumbent banks.

Jim, the targeting critique seems unfounded (and inflammatory). All the evidence I have seen suggests payday lenders "target" minorities only in so far as they cater to people with severe credit problems, of which minorities are over- represented. Once economic and financial characteristics are controlled for, payday lenders are no more likely to locate in minority neighborhoods or lend to minorities(see below). Please let me know of studies indicating otherwise.



The only other "targetting" that might legitimately be at issue is one that I haven't seen studied: Education level. Anecdotally, concentration of payday "lenders" in San Mateo and Alameda counties in the 2012-15 timeframe was within walking distance of significant less-than-high-school-education living circumstances,* even more so than pockets of poverty. Of course, there's such a large correlation between "lower education level" and "lower income level" that in an urban area it may well be impossible to distinguish them, so "in Denver" may not be a good study locus... but in other communities in Colorado, it might be.

* Including homeless encampments.

I thought that too, but then I did the study I linked to in the other comment. Check it out.

I meant to add link below. Authors show, using borrower level data from Survey of Consumer Finances that minorities are no more likely to report using payday credit than "majorities" with same financial and credit profile.

There are reasons to object to payday lenders, but "targeting minorities" is not among them.

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