In a healthy market, both suppliers and consumers thrive over the long term. When industry profitability is aligned with consumer well-being, markets flourish and individuals, families, neighbourhoods, and ultimately our whole society benefit. Unfortunately, there are countless examples of unhealthy markets where profitability and customer well-being don’t align.
In the recent “Inequalities” issue of Comment, Stephanie Summers brought attention to one market where consumer and supplier success are out of sync: the payday lending industry. Summers pulls no punches in her evaluation of the current state of this market: It preys on the poor, and it seeks profit maximization over human flourishing, practices that lead into the trap of debt rather than helping users get out of a financial pinch. Her article is a justified case of moral outrage.
At Cardus, we don’t think of morality floating in a realm of unattached “values”; rather, morality must be constitutive of the variety of ways we live together. To say that payday lending is morally problematic is also to say that the underlying economics of payday lending are morally problematic.
Under the current operating model, payday lenders lose money on first-time borrowers and so must rely on repeat borrowers to drive profits. Unlike banks and credit unions, payday lenders have no incentives to encourage consumer saving and investment and rely heavily on loan volumes to cover operating costs. In the pursuit of profit maximization, payday lenders have created a loan structure that encourages repeat usage and dependency. With loan terms of two weeks or fewer, interest rates that can reach over 900 percent APR (in Canada; as Summers notes, they’re much higher in the United States), and no ability for consumers to improve their credit rating, payday loans put borrowers (many of whom have little financial flexibility) at high risk of entering a cycle of payday-loan debt. As a result payday loans act as an economic drain on users, hindering their ability for upward economic mobility and growth. They also direct money toward loan payments and away from savings and productive expenditures. This has a ripple effect that burdens health care, mental services, food programs, and the productivity of our economy. Instead of helping consumers flourish, payday loans are an economic deadweight on individuals, families, and society. What is perhaps most frustrating is that many of these customers have the potential to move upward on the economic ladder.
The payday-loan industry is thus an “anti-market” industry, and it is for this reason that Cardus is working to bring renewal to the small-sum-loan space.
But what does renewal look like? What do we do with that moral outrage? How might we channel our legitimate concern for the poor into a market that builds instead of destroys? Those questions are harder to answer.
Many have struggled with how best to respond to the controversial practice of payday lending. The problem is complicated by evidence that users may be worse off without access to these lenders. For many households in a financial pinch, payday loans are the best if not only option. If access is restricted, users with no other accessible alternatives may face crippling charges on late bills, be unable to weather a financial shock, or turn to illegal lenders to meet their needs. Proponents of the industry point to this evidence and insist that the best way forward is to leave the industry alone; opponents advocating for regulatory reform point to usurious interest rates and predatory lending practices. Both sides have valid arguments. So what is the best way forward?
Many jurisdictions across North America have recognized both the benefits and harms of the industry and have thus sought to introduce regulation that both supports the industry and protects consumers. But there is a problem with a solely regulatory approach to payday loans. Aside from the risk that excessive regulation will restrict access, regulation is limited in its ability to transform the underlying economics of the industry, and, as outlined above, it is the underlying economics driving its problematic structure.
So while regulation can play a role, what consumers really need is access to safer, more productive forms of credit, credit that can satisfy the demand for payday loans while supporting upward economic mobility rather than hindering it. Innovative small-sum credit alternatives can provide that access, but the question remains: How do we encourage development and innovation in this space, especially when the economics of the market are not favourable?
With low margins and higher-risk borrows, the limited profit potential of the small-sum-loan market is a significant deterrent to many traditional financial institutions entering the market. At Cardus, we believe the solution lies in utilizing the strengths and resources of various spheres within our shared social architecture. Partnerships across sectors can help change the underlying economics of this market to better align enterprise profitability with the macroeconomic good and human flourishing. Even if partnerships do not significantly improve profit incentives, partnerships with community-focused institutions can provide the resources and momentum needed for initiatives that value the aggregate good over private financial returns.
Cardus is working to link financial architecture with community architecture to catalyze innovation and development in this space. Our work here is just beginning, but we believe widespread, financially sustainably, fair, and productive alternatives to payday loans are within reach and necessary for the common good.
You can be part of addressing this problem. Help us help the poor by building better markets. Join us.