A list of the terms our society uses to describe payday lenders almost tells you everything you need to know. It reads a bit like a description of a B-grade horror film: predators, thieves, vampires, slave-drivers, or (my favourite) rapacious usurers.
But if they're so awful, why are they everywhere? Why is it that, despite a seemingly universal hatred for them, they have popped up like mushrooms in cities across Canada?
The fact is that payday loans are awful. But they can also be a life saver when the need for cash is urgent and credit from traditional sources is unavailable.
Consider, for example, a family whose hydro bill is in arrears and the utility company is threatening to disconnect their service. If the bill is $200, a ten day payday loan in Ontario will cost the family $42. If their hydro was disconnected, it will cost at least $95 just to have the service reconnected. If they're unable to turn to family or friends, or to get credit elsewhere, a payday loan is not only their best option for credit, it makes the economic sense.
But, as we say in our new research report Banking on the Margins, this scenarios damns the entire industry with faint praise. Payday loans do help some people, but the critics are also right. The loans and the companies that provide them are structured and incentivized to keep their customers dependent on their services. The lack of screening to ensure repayment, the short loan terms, the high interest rates, and the repayment terms (users must pay back both the principle and the interest in one lump sum) all combine to tilt customers away from the Scylla of short-term ruin into the Charybdis of long-term debt.
This debt has long term costs to individuals and society. Research suggests that payday lending is associated with increased family breakdown, negative health outcomes, increased crime, and a host of other social ills. In Canada, this leaves the public to deal with the consequences of private financial transactions between payday lenders and their customers.
So what should we do?
Simply doing away with payday loans or instituting hard interest rate caps or other restrictive regulations will help some, but it will also hurt others. Our report notes that, while we are unlikely to solve the payday loan problem, we can take small steps to shape a better market for those in desperate need of cash. And to do so will require a renewed commitment from financial institutions, targeted government action, and community support.
Government has an important, but limited, role to play. We recommend that governments focus their efforts less on interest rate caps, and more on altering the structures which create dependency. The example of Colorado, which lengthened loan terms and made other targeted changes to repayment structures, allowed payday providers to continue to operate while significantly reducing the number of repeat borrowers.
But the real action is with financial institutions. While credit unions are taking the lead and experimenting with new products that can meet short-term cash needs in their communities, the clout of the big-banks remains unused. We recognize that publicly traded banks are incentivized to pursue higher net worth customers, but banks need to recommit to providing products for customers on the financial margins. It's akin to caring for the soil in which their profits grow. We suggest moving their corporate social responsibility programs away from shiny photo-ops that are only tangentially related to finance and towards initiatives that are integral to their value chain. Payday loan alternatives are a perfect place to start.
And community groups can help as well. Community minded charitable foundations can pool funds to provide loan loss reserves which could reduce the risk for credit unions providing these services to their communities. Governments might also provide this backing, either alone, in partnership with community groups, or through social impact bonds which reward programs that meet goals of debt reduction.
"The borrower is the slave of the lender," says the ancient proverb. If we want to liberate those caught in the cycle of debt, we'll need a renewed effort to shape market-based, community-focused, efforts to create real alternatives.
This piece also appeared in the Winnipeg Free Press.
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