Three Questions: Prof. Paul Goldsmith-Pinkham on Payday Loans and Consumer Protection
On February 6, the director of the Consumer Financial Protection Bureau (CFPB), Kathy Kraninger, announced a major change to payday lending rules. The move weakened protections instituted by the Obama administration by no longer requiring lenders to confirm a borrower’s ability to repay before making a loan. Critics fear the change will lead more consumers to get ensnared in loans they can never pay off, while proponents suggest it will unshackle the lending industry. We asked Yale SOM economics professor Paul Goldsmith-Pinkham about what this change might mean to financially strapped Americans.
What role do payday lenders play in the financial lives of lower-income Americans?
Payday lenders provide credit by holding customers’ personal checks for a few weeks, and providing liquidity in the absence of other sources of traditional credit (e.g., credit cards). Research seems to find that consumers who find it particularly difficult to access traditional sources of credit are more likely to apply for payday loans. This may be for reasons beyond poor repayment history—they may just lack any credit history, or much formal lending. (See Morgan, Strain, and Seblani, 2012 and Bhutta, Skiba, and Tobacman, 2015.)
Will the changes to payday-loan regulations lead to borrowers getting trapped in debt, as some consumer advocates claim, or affect the availability of credit to low-income borrowers, as industry groups claim?
The answer is probably “it depends.” The research on this topic finds conflicting evidence of the impact of payday loans. There are a variety of reasons for this, but it’s probably due to heterogeneity in the usage of payday lending. For some borrowers, the payday loans are used as bridge loans to smooth shocks, and these borrowers find them extremely helpful. In a talk delivered to the California Department of Business Oversight in November 2018, economist Adair Morse made a case that since borrowers are grateful for the option of payday loans, debating whether they are inherently bad is beside the point; the system can benefit from “product improvements” that will do a better job of sorting who qualifies for such loans and how the payback terms could vary according to very specific circumstances.
However, other payday borrowers appear to repeatedly borrow in a fashion that is likely financially harmful. In a 2011 paper, “The Real Costs of Credit Access: Evidence from the Payday Lending Market,” Brian T. Melzer wrote, “I find no evidence that payday loans alleviate economic hardship. To the contrary, loan access leads to increased difficulty paying mortgage, rent, and utilities bills.” These contrasting points make it difficult to assess a clear negative or positive effect of payday loans. This is made particularly difficult as many payday borrowers are low-income and potentially vulnerable to predatory lending, but are also excluded from traditional credit markets and thus benefit from access to payday loans.
How well are consumers currently protected by the CFPB?
It’s hard to measure, and difficult to evaluate. The evidence I’ve seen seems to suggest that while banks complain about the CFPB regulations being onerous, this is not translating into big negative effects on consumer lending.