Banking and Finance Law Daily Wrap Up, CONSUMER CREDIT—Fed staff working paper analyzes effects of various state regulations on payday lending, (Sep 30, 2013)

By Richard A. Roth, J.D.

Noting that payday loans are not really a single loan product but rather a variety of products offering different amounts of credit, over different maturities, with different terms, a Federal Reserve Board Finance and Economic Discussion Series staff working paper looks at the effects that different state restrictions have on whether payday lending is beneficial or harmful for consumers. Payday Lending Regulation, by Alex Kaufman, considers five-and-one-half years of loan data from a single lender’s operations across 26 states to look particularly at the effects state laws have on repeat borrowing. According to the paper, some state laws have resulted in a significant decline on the repeated use of payday loans.

According to the paper, payday lending is widespread, but there is no consensus on whether this type of credit helps or harms consumers. So far, payday lending has largely been regulated by state governments, although the paper notes that the Consumer Financial Protection Bureau may assert the rulemaking authority it was given by the Dodd-Frank Act. The ability of states to regulate effectively was strengthened when the Federal Deposit Insurance Corporation effectively banned banks from the business in 2005.

State restrictions studied. The paper considers the effects of seven different steps that state governments have taken to regulate payday lending:

1. capping the interest rate or annual percentage rate lenders may charge;

2. capping the maximum amount that can be lent;

3. limiting loan maturities, with some states imposing maximums and others imposing minimums;

4. limiting the number of loans a consumer may have outstanding at the same time;

5. prohibiting or restricting rolling over loans;

6. requiring “cooling off” periods in between loans; and

7. requiring lenders to offer an alternative, amortizing loan in addition to the payday loan.

Study results. Not surprisingly, the study found that caps on loan prices tend to be effective in regulating those prices; on the other hand, caps on loan sizes were found not to be fully effective. Both caps resulted in higher delinquency rates.

Price caps, maximum term limits, prohibitions on rollovers, and mandatory cooling off periods all were effective in reducing repeated borrowing, the study determined. Maximum loan terms seemed to induce more repeat borrowing, although the author could not suggest why that would be the case.

The study also looked at what happened when states changed their laws during the relevant time period. Changes to loan size caps and the imposition of simultaneous borrowing restrictions seemed to have little effect on the total amounts that consumers borrowed. Increases in price caps resulted in increases in delinquencies, the study found, while price cap decreases resulted in decreases in delinquencies.

Requiring cooling-off periods, and a comparable limit on the number of loans per year, resulted in significant decreases in the amount of repeat borrowing, the study said. Repeat borrowing also declined when fee caps rose.

The Fed noted that staff working papers are “preliminary materials circulated to stimulate discussion and critical comment.”

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