Thomas Jefferson once wrote: “I believe that banking institutions are more dangerous to our liberties than standing armies.”
Banking, overall, has been severely toned down from the days of yore. In particular, the focus of regulation has been against the unethical practice of usury.
When it comes to the regulation of usury in the United States, it is the states that have the primary powers. They can create legislation on how much interest can be charged legally among other things. However, a queer situation exists when it comes to payday loans or payday advances where the federal government also holds the power to regulate, due to the high rate of bankruptcies among borrowers and usurious practices prevalent in the industry.
With Fintech firms ready to enter the payday loan business and being able to skip state regulations by obtaining a limited purpose bank charter, we examine if we are entering into a new era of banking horrors.
Why payday lenders suck
Payday lenders suck. Let us be direct about this and there is no other way to put it.
As the Federal Reserve publication puts it:
“Except for the ten to twelve million people who use them every year, just about everybody hates payday loans. Their detractors include many law professors, consumer advocates, members of the clergy, journalists, policymakers, and even the President!”
There is also no shortage of payday lenders, with their branches outnumbering Starbucks coffee shops in the United States, according to the Fed.
Highlighted are the high prices of a payday loan, which is typically short-term and high interest. As the publication wrote: “The typical brick-and-mortar payday lender charges $15 per $100 borrowed per two weeks, implying an annual interest rate of 391 percent!”
Another persuasive complaint against payday lenders is that they entrap people into debt. Rollovers of payday loans mean that consumers are hit with expensive fees. As the website of Consumer Financial Protection Bureau (CPFB) explains:
“If you roll over the loan multiple times, it’s possible to pay several hundred dollars in fees and still owe the amount you borrowed. For example, if you roll over a $300 loan with a $45 fee three times before fully repaying the loan, you will pay four $45 fees, or $180, and you will still owe the $300. So, in that example, you would pay back a total of $480.”
More entrants expected
The Office of the Comptroller of the Currency (OCC) is planning to offer a federal charter for Fintech companies for the purposes of one of the three core banking functions, which are; lending money, paying checks or receiving deposits, according to a report by American Banker. This proposal by the OCC has been met with resistance by two Democratic Senators namely Sen. Sherrod Brown (D-Ohio) and Sen. Jeff Merkley (D-Ore). It has also attracted the attention of more than 250 organizations, which have urged the OCC not to go ahead with its plans. According to stopthedebt.org:
“More than 250 groups sent a letter to Comptroller of the Currency Thomas J. Curry urging him not to grant national charters to financial technology firms, which could preempt state oversight and state consumer protection laws that protect consumers and small businesses from abusive financial practices. The letter by state advocates, affordable housing providers, national civil rights organizations, small business advocates, and many others sends a strong message to the OCC about the risk it creates to state-level protections against predatory lending.”
More not necessarily merrier
Payday lenders are overwhelmingly present in areas where minorities reside. The most likely borrower is someone who is already encountering financial troubles.
As The Pew Charitable Trusts states in their report titled ”PayDay Lending in America, Who Borrows, Where They Borrow and Why”:
“Most payday loan borrowers are white, female, and are 25 to 44 years old. However, after controlling for other characteristics, there are five groups that have higher odds of having used a payday loan: those without a four-year college degree; home renters; African Americans; those earning below $40,000 annually.”
Can having more Fintech companies operate in this sphere actually make things better for the borrowers? One line of thought is that giving unrestricted access to Fintech companies will only compound the misery of the borrowing public. Senators Merkley and Brown were cited in the American Banker as saying: “The OCC's plan "could also allow predatory alternative financial services providers to spread more quickly given the blessing of the federal government and elimination of state-based protections for working class Americans”.”
The opposing line of thought being that more competition is likely to help interest rates southwards and actually act as a boon to the cash-starved borrowers. Federal level regulation may also help bring uniformity to an industry that is insidious and prevalent in one form or another across the United States.
Although states have struggled for ages and some have even tried to ban payday loans outright, the popular demand for quick and easy credit has ensured that lenders have survived. It would then make sense to allow Fintech payday lenders to operate but still make them subject to state usury laws as well.