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The Effectiveness of Payday Loan Regulation

Definition of law
As months and years pass, the payday loan industry becomes more regulated and divided.

Most states have at least one pending law that could limit or eradicate payday lending. Some laws pass, others fail, but what happens to the state itself?

Loans.org spoke with financial writers, attorneys and consumer advocates who frequently cover the payday loan industry to see what impact the many forms of legislation have on the country’s lending economy.

The Outcome of Legislation

In 2011, several pieces of legislation passed while many others died in the committee. Some of the larger changes were seen in Arkansas and Indiana.

In Arkansas, both House Bill 2021 and Senate Bill 259 were proposed to repeal the Check-Cashers Act and protected borrowers from unlawful interest rate charges. The governor signed S.B. 259 in March of 2011.

In Indiana, the approved bill was less about regulation and more about consumer education. H.B. 1410, which passed in February, required that payday lenders display their business locations on pamphlets, include a toll free contact number and a number for credit counseling, among other items.

Other laws were simply tweaks to previously signed bills. One successful bill in California was A.B. 1158 which was introduced by Assembly Member Charles Calderon. The bill, after several amendments, was passed in assembly. The existing law was changed and allowed for a check’s face amount for a deferred deposit transaction to be $500. Previously it was limited to $300.

But not all states were able to claim victories over the payday loan industry.

One state that faced multiple rejections was Mississippi. Out of the nine bills that were proposed, eight died in committee. The only one that survived and was later signed by the governor, was H.B. 455. Several of the state bills that died in legislation that year were H.B. 16, H.B. 780 and S.B. 2242.

Some states do not prioritize payday regulation and only offer up one or two bills per year. One reason could be because of previous year’s failures.

Andrew Schrage, founder of Money Crashers, said that when New Mexico tried to regulate the industry in 2007, the laws were considered to be a failure.

“The language of the law was so narrowly worded that the industry simply shifted its business model and the nature of the products it offered,” Schrage said.

Bills proposed in 2011 have predominantly passed or died by now, but 2012 gave legislators more time to construct more regulation. Some states are ahead of the game by a long shot. According to the National Conference of State Legislatures, for 2012, policymakers in Illinois created nine separate laws that dealt with payday loans.

Other states have similarly passionate lawmakers. Missouri has six separate pieces of payday loan legislation and California has three.

Although the pending legislation covers various aspects of the industry, most laws try to attack the interest rates offered by payday and title loan companies.

Jim Wells, president of Wellspring Consulting International, said this is a problem, and one of the largest, because the new legislation fails to “recognize that although it can reduce availability of legal, community-based, non-bank lenders, it can do nothing to reduce consumer demand for small dollar loans.”

During the beginning of the Financial Crisis, Wells said banks that were “making loans to anyone who could fog a mirror suddenly became selective lenders.” The aftereffect of this was that credit card accounts, credit lines, and home equity lines were closed at the time that many consumers needed them the most.

Regardless of the economy, people need small loans. Wells said that there was a thriving installment loan market made possible in the past. Firms such as Beneficial Finance, Household Finance, and The Money Store provided funds to in-need consumers. He continued stating that in states where payday firms have closed, studies have found that consumers face higher overdraft fees from non-payday lenders.

Strict payday loan legislation can be viewed in a positive manner because it attempts to protect consumers from predatory lending. But experts besides Wells believe that our current economy and structure necessitates small consumer loans.

Jay Richards, distinguished fellow for the Institute for Faith, Work and Economics, agrees that as long as scarcity exists, there will be a need for credit. Scarcity, as a part of the human condition, will continue. The only question is where people will turn to help them overcome it. Richards wonders whether consumers will continue to access it legally or if they will be forced to turn to black markets for funds.

“We do not help the poor and disadvantaged by restricting their economic options and their access to legal credit,” Richards said.

Credit abuse does occur in the payday loan industry, but it also occurs in every single financial sector. Yet legislators find it necessary to burden one area and leave others wide-open.

“Misuse doesn’t invalidate proper use,” he said.

Instead of having outside and often times illogical regulation, the payday loan industry could be regulated by the free market. Richards said that when entire socioeconomic classes are prohibited from lending options due to arbitrary criteria, it “artificially restricts” free competition.

“The best way to have a customer friendly, competitively price market for anything, including small dollar credit, is to have free competition of individual companies doing their best to meet the needs of consumers at a price the customers can afford,” he said.

Biased Coverage

Despite the long lists of bills proposed each year, very little coverage is concerned with the outcome and impact of these bills. When loans.org researched several of the passed bills mentioned earlier, few garnered enough coverage for a newstory.

Part of the issue could be blamed on the one-sided coverage told by media outlets. Wells said the news media doesn’t take the time to understand the payday loan industry and the product it offers.

If the industry is not researched deeply, then it becomes generalized and improperly labeled.

“The perception of poor people being taken advantage of while self-appointed activists complain is an easy storyline,” Wells said. “They fall into the trap of seeing banks with white hats and PDA firms with black hats.”

But in reality, the industry that supposedly needs more regulation is already highly regulated. The Community Financial Services Association of America (CFSA) and the Online Lenders Alliance (OLA) both have codes of conduct for lending partners. These codes include payment plans, support, and pricing guidelines.

When a consumer needs to file a complaint about a lender, they can also turn to the Consumer Financial Protection Bureau (CFPB) who will assist in resolving the dispute.

The CFPB covers a huge sector of the lending industry, but some fear its overarching leverage.

Richards is concerned by the CFPB because of its freedom and minimal government oversight. It is not controlled by Congress or the Fed, yet it is given jurisdiction over all the financial sectors of the economy. He said that a “sovereign entity” such as the CFPB should not exist in the United States, a country with checks-and-balances.

“Despite it’s name, consumers should not feel protected by the CFPB,” Richards said.

Regardless of the variations of lenders, the needs of consumers and the intricacies of the laws, the payday loan industry remains a black-and-white debate. But in the near future, any further regulation or expansion of the industry will likely occur in the grey arena, where consumers request small loans and businesses find a way to provide for that need.