How Banks Slid Into the Payday Lending Business

Meet the new payday loan. It looks a lot like the old payday loan.

Under the Obama administration, the Consumer Financial Protection Bureau attempted to rein in abusive payday lending, by, among other measures, forcing lenders to ensure borrowers had the means to pay back their loans. The Trump administration, under interim CFPB Director Mick Mulvaney, is looking to roll back those rules and give payday lenders, who as an industry donated significant amounts of money to Mulvaney when he was a congressman, more room to operate. A high-profile rule proffered by the CFPB to govern payday loans is under review, and Mulvaney’s CFPB has also dropped cases the bureau had previously pursued against payday lenders.

Payday lenders have taken notice, and are already adapting their business to evade regulation. Meanwhile, small-dollar, high-interest lending has migrated to other parts of the financial industry, including traditional banks. Banks aren’t actually calling their loans “payday loans” — preferring names like “Simple Loan” — but the problems, including high costs and the potential for creating a debilitating cycle of debt, are largely the same.

Payday loans are short-term loans, so named because they are meant to be paid back when the borrower earns her next paycheck. The interest rates on these loans are high, running up to 400 percent or more. (For comparison’s sake, a borrower will pay about 5 percent interest on a prime mortgage today, and between 15 and 20 percent on a credit card.) Payday lenders tend to cluster in areas where residents are disproportionately low-income or people of color, preying on economic insecurity and those for whom traditional lending and banking services are unavailable or insufficient.

It’s not only those high interest rates that make the loans lucrative for lenders and damaging for borrowers. Much of the income payday lenders derive comes from repeat business from a small population of borrowers who take out loan after loan after loan, engaging in so-called “churn.” According to the CFPB, more than 75 percent of loan fees come from borrowers who use 10 or more loans per year. These borrowers wrack up big fees that outweigh the economic benefit provided by the loans and become stuck in a cycle of debt.

This is serious money we’re talking about: Prior to the Obama administration’s attempt to more strongly regulate the industry, payday lenders made some $9.2 billion annually. That total is down to about $5 billion today, even before the Obama team’s rules have fully gone into effect. Meanwhile, many states have also taken positive steps in recent years to regulate payday lending. (The loans are also outright banned in some states.)

However, that doesn’t mean payday lending is going out of style.

For starters, old payday lenders have revamped their products, offering loans that are paid in installments — unlike old payday loans that are paid back all at once — but that still carry high interest rates. Revenue from that sort of lending increased by more than $2 billion between 2012 and 2016. The CFPB’s rules don’t cover installment-based loans.

“They claim that these loans are different, are safer, are more affordable, but the reality is they carry all the same markers of predatory loans,” said Diane Standaert, director of state policy at the Center for Responsible Lending. These markers include their high cost, the ability of lenders to access borrowers’ bank accounts, and that they are structured to keep borrowers in a cycle of debt. “We see all of those similar characteristics that have plagued payday loans,” Standaert said.

Meanwhile, big banks are beginning to experiment with small-dollar, short-term loans. US Bank is the first to roll out a payday loan-like product for its customers, lending them up to $1,000 short-term, with interest rates that climb to 70 percent and higher. (Think $12 to $15 in charges per $100 borrowed.)

Previously, American’s big financial institutions were very much discouraged from getting into small-dollar, high-interest lending. When several major American banks, including Wells Fargo and Fifth Third, rolled out short-term lending products prior to 2013, they were stopped by the Office of the Comptroller of the Currency, which regulates national banks. “[These] products share a number of characteristics with traditional payday loans, including high fees, short repayment periods, and inadequate attention to the ability to repay. As such, these products can trap customers in a cycle of high-cost debt that they are unable to repay,” said the OCC at the time.

In October 2017, however, the OCC — now under the auspices of the Trump administration — reversed that ruling. In May 2018, it then actively encouraged national banks to get into the short-term lending business, arguing that it made more sense for banks to compete with other small-dollar lenders. “I personally believe that banks can provide that in a safer, sound, more economically efficient manner,” said the head of the OCC.

However, in a letter to many of Washington’s financial regulators, a coalition of consumer and civil rights groups warned against this change, arguing that “Bank payday loans are high-cost debt traps, just like payday loans from non-banks.” Though the terms of these loans are certainly better than those at a traditional payday lender, that doesn’t make them safe and fair alternatives.

Per a recent poll, more than half of millennials have considered using a payday loan, while 13 percent have actually used one. That number makes sense in a world in which fees at traditional banks are rising and more and more workers are being pushed into the so-called “gig economy” or other alternative labor arrangements that don’t pay on a bi-weekly schedule. A quick infusion of cash to pay a bill or deal with an unexpected expense can be appealing, even with all the downsides payday loans bring.

Payday lenders seem well aware of the state of regulatory flux in which they find themselves; they have made more than $2 million in political donations ahead of the 2018 midterm elections, the most they’ve made in a non-presidential year, according to the Center for Responsive Politics.

That’s real money, but it’s nowhere near as much as borrowers stand to lose if payday lending continues to occur in the same old way. In fact, a 2016 study found that consumers in states without payday lending save $2.2 billion in fees annually. That’s 2.2 billion reasons to ensure that small-dollar lenders, big and small, aren’t able to go back to business as usual.