In the past five years, our economy has slumped, stabilized and stalled. The too-big-to-fail banks were bailed out by the government, and Congress created a new agency to ensure financial protection for consumers, but the average American continues to have a range of financial security concerns.
For most, financial security and the availability of credit go hand-in-hand. Without credit, most Americans wouldn’t be able to buy a house or deal with unexpected expenses. Many use conventional credit arrangements like credit cards and home equity loans.
But for those without the credit history necessary to qualify for these loans or for those who need funds quickly to deal with unexpected expenses, alternative financial credit – such as payday loans – are an important option. It is no surprise that the use of these products is increasing.
A payday loan is a short-term, small-dollar loan (averaging about $350 of principal for a two-week period) that does not require a credit check, but does require a steady income and an active checking account. The typical fee for a $100 payday advance is cheaper than the fee for bouncing a $100 check.
In a study released last summer, I found two important factors contribute to the increase in alternative financial services: The Great Recession caused household income for many families to decline, and conventional sources of credit are not accessible to many lower-income households.
According to the FDIC, 1 in 5 U.S. households, or 24 million Americans, are underbanked, meaning poor access to mainstream financial services. In North Carolina alone, 21 percent of households are underbanked. Nationally, reduced access to financial services falls disproportionately on minority groups, with 54 percent of black and 43 percent of Hispanic households unbanked or underbanked.
This results in a restriction of credit for a growing segment of Americans. A survey by the American Payroll Association found that 72 percent of American employees are living from paycheck to paycheck, a situation in which a family may be unable to cover expense shocks. Alternative banking options, like payday loans, fill this gap.
In our political discourse, much is made about bridging the gap between economic classes. To the extent financial services exemplify this gap, three strategies have evolved to address the chasm between better-off Americans who use mainstream financial services and poorer citizens who resort to alternative financial services: prohibition, regulation and inclusion. These strategies have been particularly evident in payday lending.
Prohibition. Unfortunately, critics of payday lending overstate, for their own political purposes, the harm arising from use of these loans. Resulting attempts to prohibit the product reflect an impulse that has been evident since our country’s founding: making unlawful those activities deemed morally offensive, including alcoholic beverages, gambling, lotteries, etc. Rendering activities for which there is significant demand illegal, however, not only drives them underground, where providers tend to offer a product that is inferior, but also obligates government to the costs of oversight, prosecution and incarceration.
Regulation. Regulation, on the other hand, allows operation in the open, affording a measure of surveillance, permitting government to tax transactions as well as a means for penalizing noncompliant operators.
Inclusion. Inclusion encourages mainstream financial service providers to make products more available for consumers who are not served by the primary financial market, as well as acknowledges the role that payday lenders play in the economic life of those outside the financial mainstream.
A good case can be made that economic inclusion of mainstream financial service providers is desirable and the ultimate goal. It is nevertheless essential to recognize that consumers may elect to avoid mainstream banks because of inconvenience or previous adverse experiences.
Prohibition, on the other hand, not only drives consumers to black-market lenders, but also impedes the development of a continuum of financial products between traditional banking and the black market. Regulation of payday lending, then, serves as a pragmatic middle ground, offering consumers knowledge about their credit alternatives, providers the option to serve a neglected market and government a means of monitoring financial transactions and the behavior of borrowers and lenders.
As North Carolina’s policymakers work to identify regulations that ensure a diverse set of credit options are available to residents, it is crucial to keep these points in mind and to be wary of critics of payday lending who seek to eliminate the product by promoting flawed research and distorting the dialogue around this important credit option.
David Stoesz is a professor in the Department of Social Work at Mississippi Valley State University and a professor emeritus at Virginia Commonwealth University.