Wednesday, October 04, 2006

Payday Lenders?

My morning and evening commutes today featured various reports on payday lending in Canada on the CBC Radio I normally have on in the car.
Now my neighbourhood, described recently in a local newspaper as 'rough' (I do not think of it that way), features several of these small offices along the main street.
The morning news reports were simply that the Federal governmant was planning to do 'something' about them. There was no clear statement of what. But apparently, they might charge interest rates as high as 1000%!!!!!!!!!!!!!
Each time this was said, the CBC reporter was clearly shaking her head in horror.
With very little to do in the slow-moving morning traffic, I tried a little thought experiment. A friend is in temporary difficulty and needs $100. So I give him $100. The next day he can pay me back and buys me a pint of ale (Smithwick's, if I get to choose, roughly $6.25 in the local pubs) as a thank-you. Let us consider that as the interest on this loan.
So what interest rate have I collected?
Let us assume interest is compounded monthly, a reasonable approach.
And let us make a common assumption that all months have 30 days.
OK so the monthly interest I have obtained is 30 times $6.25 = $187.50. So the monthly accumulation rate of this loan moves us from $100 to $287.50. So each month of his owing me for the original $100 what he owes me increases by a factor of 2.875. At the end of 12 months Excel tells me he will owe me $110,921.65! Which makes the annual interest rate I got paid by that beer 110921%!!!!!! (yes, you need to know that I must view the pint is worth $6.25, and I do).
OK I used compounding in a mischievous way. If we just did a linear extrapolation, the annual interest rate would be only 6.25*365 = 2281.25%!!!!!!!!!
Man those CBC reporters are conservative! 1000% is nothing.

OK I am playing games above - for a real payday loan operation there would surely be transaction cost and the like that would not be construed as interest. But in fact a provincial supreme court in Canada has apparently ruled otherwise. From the Wikipedia article I linked to above:
A OK charged its customers 21% interest, as well as a "processing" fee of C$9.50 for every $50.00 borrowed. In addition a "deferral" fee of $25.00 for every $100.00 was charged if a customer wanted to delay payment. The judge ruled that the processing and deferral fees were interest, and that A OK was charging its customers a criminal rate of interest. The payout as a result of this decision is expected to be several million dollars.

Take note of a key point for later - this ruling reflects that there is a current federal law in Canada restricting 'interest' to 60%.

Anyway, having figured out on my morning drive that the concern about a 1000% interest rate was idiotic, I wondered what the problem could be.

My drive home filled me in some more, again thanks to the local CBC. They had a professor on, one who had apparently advised the federal government, and who, in my view, made both sense and failed to.

He started by saying something very sensible - that what the federal government was planning was to simply drop their regulation. And leave it to the provinces. He pointed out to yet another shocked CBC reporter that the interest rates could be in the millions of percentages per annum (and you can see above why, and why that is utterly insignificant).

He also pointed out there was more to this than I understood.

At one point he said this was a phenomenally inefficient industry with customers facing far higher costs than they had to. And I was baffled.

My thinking was: here is an industry with pretty much NO technical barrier to entry. All you need is access to cash. And maybe a cheesy storefront office. So how could it be inefficient? I still do not know the full answer but one thing he pointed out is that banks and credit unions are somehow barred (by regulation) from entering this business. Why??????? Who better?

And so likely there are other artificial barriers to entry. Surely again regulatory.

It is becoming ever clearer from these reports that almost everyone will be better off when all the existing regulation simply disappears. Surely competition for business here will drive the costs down so people in need of this service will be well-served; after all, almost all the inefficiencies seem traceable to current regulation.

And there is a sinister side to some proposed regulation. There are jurisdictions where regulation has driven this industry into extinction. And what is the effect of that? People who could use this service do not have it available! And clearly this is NOT the high end of the spectrum - after all, almost anyone who can qualify for a credit card has no need of these services. So basically, we wind up depriving non-privileged people the ability to have a service they might well want.

This is not terribly unlike minimum wage laws - and let me just gratuitously point to another fine post from Chris Dillow.

By the time I got home I was not able to listen to the CBC report with the same clarity. But oddly, the professor, who had convinced me getting rid of regulation was a good idea, still wanted regulation (OK not so odd - he is a professor), and the CBC reporter was just confused. But sure that WE had to do something. I think that maybe what we have to do is leave people alone!

(By the way be careful about your notions about who uses payday lending - it is not the poorest of the poor - after all it is PAYDAY lending.)


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