How FinTechs Can Disrupt the Payday Loan Industry
The death of payday loans in the United States has long been predicted, as opponents complain that short-term, high-interest loans offer consumers little more than an opportunity to fall into a debt trap. debt that could take years to emerge. Will competition from FinTechs finally trigger the demise of the industry?
The US government has put in place intermittent crackdowns on the high costs of payday loans. For example, the 2017 publication of the United States Consumer Finance Protection Bureau final payroll rules required short-term lenders to assess borrowers’ ability to repay before granting credit, and also imposed limits on how often borrowers could renew their loans.
But questions quickly arose as to whether these requirements would actually take effect. While supporters applauded a new national standard as a way to protect vulnerable consumers, opponents called the rule a clear case of federal overshoot. They claimed the CFPB “protected” consumers to death by cutting them off from an easy source of loans when people needed money the most.
CFPB director Richard Cordray left shortly after the the rules are out, replaced first by interim director Mick Mulvaney, then definitively by Kathy Kraninger in 2018. Last year, the CFPB signaled its intention to do adjustments to the final rules, thereby eliminating the requirement that lenders establish the repayment capacity of potential borrowers. The potential rule changes were also intended to remove limits on repeat borrowing by a single consumer.
Nothing concrete happened for over a year, until COVID-19 struck and the CFPB kicked in. Last month Kraninger canceled the rules of repayment capacity and repeated loans.
“The Bureau is taking steps to ensure that consumers and market participants understand that the same rules continue to govern the consumer financial market,” the CFPB chief said in announces the move.
It is estimated that the changes will save small lenders over $ 7 billion per year, and therefore have been very popular with the industry – but they have been very popular with the industry. UNpopular with opponents of payday loans.
“It’s not just about consumer protection – it’s about safety and soundness,” said Jeremy Kress, assistant professor of business law at the University of Michigan. Vox. “Lenders do not have to make loans to people if they cannot reasonably determine in good faith that the borrower has a reasonable capacity to repay the debt. “
He noted that consumers make bad decisions in desperate situations and that unscrupulous lenders have historically used this to their advantage. Kress argued that the COVID-19 era is exactly the wrong time to deregulate payday loans.
Enter the competition
But payday lenders might not want to come out clearly just yet – because even if the government isn’t coming for them, more and more competing products are. And the problem with being the “lender of last resort” is that borrowers are always open to a better deal.
One form could come from FinTechs who are willing to take out short term small dollar loans, but do so differently from typical payday lenders.
Square had the most recent deployment of this segment, recently testing loans up to $ 200 through the Square Cash app. “We are always testing new features in Cash App and have recently started testing the ability to borrow money with approximately 1,000 customers,” a Cash App spokesperson said in a statement. “We look forward to hearing their feedback and learning from this experience.”
Loans start at $ 20, with payment due within four weeks (plus a one-week grace period for users who miss the deadline). The loans have a 5% fee and no interest for four weeks, plus a one-week grace period.
After that, Square charges 1.25% uncompound interest each week. This is in addition to an annual percentage rate of 65 percent. Although it is high, it is still well below the APR of almost 400% which some payday lenders charge.
And while building a better short-term loan is one way to challenge payday lenders, another school of thought argues that workers wouldn’t need to borrow at all if they didn’t have to. wait two weeks to receive their salary. In fact, some financial institutions (FIs) and FinTechs argue that workers should get paid instantly every day.
As Warren Perlman, CIO at a global human capital management company Ceridiansaid Karen Webster in a recent conversation, workers often turn to payday loans to fill a cash hole that doesn’t have to exist. He said it was just a relic of a two-week pay cycle that is out of step with the needs of modern workers, especially during the COVID-19 pandemic.
Perlman thinks it’s high time to reimagine how and when employees get paid. “Workers need to be able to access their funds as available to them, especially in times of downturn,” he said.
He sees payday loans bad for those who take them – and bad for employers, because workers who focus on eliminating debt aren’t as focused on their jobs. Perlman said employers can play a critical role in supporting the financial well-being of employees – not to mention worker retention and job satisfaction – by giving employees faster access to pay.
After all, if consumers have access to cash when and how they need it, payday loans become less attractive, regardless of the laws that govern the segment.
The bottom line: Even if the rules don’t change, the competitive landscape will likely continue to expand as more players try to disrupt an industry that no one really loves so much.