Q. So, there’s news today about JPMorgan changing some policies about payday loans — what are they, and why is this important?
A. These are the old school, short term, unsecured loans that carry enormous interest rates– $15 on a two week $100 loan (close to 400%)! Surprsingly, Pew reports that 12mm Americans (6%) have used them… And, like a lot of things, technology has really helped make them big: more than a dozen states have outlawed them, and more are moving that way, but the lenders just move offshore and use the internet.
Q. So, what role are the big banks playing, exactly? Surely they’re not making the loans…
A. No. But they’re enforcing the loans. In a modern payday loan, the lender verifies employment, ensures the employee’s check is direct deposited, and gets permission for automatic debiting. One issue has been that if there are insufficient funds in the account, there are fees for that… and the lender keeps hitting the account over and over, driving up fees on someone who, obviously, just doesn’t have the money. Worse, a lot of bank won’t even let the borrower close the account with the claim outstanding, so it’s a terrible downward spiral.
Q. But very profitable for the lenders, I guess.
A. Yes, although, to be fair, not quite as profitable as those ridiculous rates would make you think. A few studies, including one by the FDIC, indicate that between the logistics of doing these things and the charge off rates, the net profits aren’t quite as obscene as you’d guess.
Q. Since payday lenders aren’t typical financial institutions, where are they getting their capital to make the loans in the first place?
A. Ah, that’s an interesting question. The fact is that a lot of hedge funds invest in these things, although they hate to talk about it. In a zero interest rate environment, they just can’t pass this stuff up.
Q. So what’s the future look like here?
A. If the banks don’t act as enforcers on these loans, the industry will shrink, no doubt about that. A lot of consumer protection advocates will say, “Thank God”, but payday loan proponents will say… OK, but where do these folks go when then need to borrow to buy groceries?