A blog post about payday lending, “Reframing the Debate about Payday Lending,” posted on the New York Fed’s website takes issue with several “elements of the payday lending critique” and argues that more research is needed before “wholesale reforms” are implemented.  The authors are Robert DeYoung, Ronald J. Mann, Donald P. Morgan, and Michael R. Strain.  Mr. Young is a Professor in Financial Institutions and Markets at the University of Kansas School of Business, Mr. Mann is a Professor of Law at Columbia University, Mr. Morgan is an Assistant Vice President in the New York Fed’s Research and Statistics Group, and Mr. Strain was formerly with the NY Fed and is currently Deputy Director of Economic Policy Studies and a resident scholar at the American Enterprise Institute.

The authors assert that complaints that payday lenders charge excessive fees or target minorities do not hold up to scrutiny and are not valid reasons for objecting to payday loans.  With regard to fees, the authors point to studies indicating that payday lending is very competitive, with competition appearing to limit the fees and profits of payday lenders.  In particular, they cite studies finding that risk-adjusted returns at publicly traded payday loan companies were comparable to other financial firms.  They also note that an FDIC study using payday store-level data concluded “that fixed operating costs and loan loss rates do justify a large part of the high APRs charged.”

With regard to the 36 percent rate cap advocated by some consumer groups, the authors note there is evidence showing that payday lenders would lose money if they were subject to a 36 percent cap.  They also note that the Pew Charitable Trusts found no storefront payday lenders exist in states with a 36 percent cap, and that researchers treat a 36 percent cap as an outright ban.  According to the authors, advocates of a 36 percent cap “may want to reconsider their position, unless of course their goal is to eliminate payday loans altogether.”

In response to arguments that payday lenders target minorities, the authors note that evidence suggests that the tendency of payday lenders to locate in lower income, minority communities is not driven by the racial composition of such communities but rather by their financial characteristics.  They point out that a study using zip code-level data found that the racial composition of a zip code area had little influence on payday lender locations, given financial and demographic conditions.  They also point to findings using individual-level data showing that African American and Hispanic consumers were no more likely to use payday loans than white consumers who were experiencing the same financial problems (such as having missed a loan payment or having been rejected for credit elsewhere).

Commenting that the tendency of some borrowers to roll over loans repeatedly might serve as valid grounds for criticism of payday lending, they observe that researchers have only begun to investigate the cause of rollovers.  According to the authors, the evidence so far is mixed as to whether chronic rollovers reflect behavioral problems (i.e. systematic overoptimism about how quickly a borrower will repay a loan) such that a limit on rollovers would benefit borrowers prone to such problems.  They argue that “more research on the causes and consequences of rollovers should come before any wholesale reforms of payday credit.”

The authors note that because there are states that already limit rollovers, such states constitute “a useful laboratory” for determining how borrowers in such states have fared compared with their counterparts in states without rollover limits.  While observing that rollover limits “might benefit the minority of borrowers prone to behavioral problems,” they argue that, to determine if reform “will do more harm than good,” it is necessary to consider what such limits will cost borrowers who “fully expected to rollover their loans but can’t because of a cap.”