In an administration and news cycle dominated by a seemingly endless stream of the president’s words and tweets, it’s the less discussed policy actions taken by the administration that are more worthy of outrage. The recent softening on the payday loan industry, relative to the strong regulation pushed by the Obama administration, is one such move that will have profound consequences for the American worker. Alan Rappeport in an article published in the New York Times, dives into a few examples of this softening including stopping investigations of fraudulent marketing practices, pulling back from lawsuits against particularly predatory providers, and halting Obama-era enforcement of tighter regulation including pushing for a repeal of the 2017 payday lending rules which would have created more oversight and tighter controls on the industry.
This is highly disappointing. The Consumer Financial Protection Bureau, established as a part of the financial regulation under Dodd-Frank, had taken particular aim at the payday loan industry under the leadership of Obama appointee Richard Cordray until he resigned last November. Recently he remarked, “I’m surprised to see any efforts aggressively to roll back efforts to rein in payday lending, because we had done extensive research on how these loans lead many people into debt traps that ruin their financial lives”
There is no better way to describe the financial ruin that these loans can cause than the words "debt trap." They are a snare that prey on the weak in moments of need and force a downward debt-driven spiral.
And yet, payday loan companies do provide a badly needed service for a deeply under-served market. A deeper dive of the drivers behind this need is necessary to understand why this industry exists.
First, the variability of part-time work schedules creates volatile income streams that hourly workers have difficulty managing expenses towards. The Economic Policy Institute in 2015 notes that almost 15-20% of the workforce have unstable shift schedules that change on a weekly basis due to the pervasive use of on-call shifts and limited hours from employers, with the lowest income workers being affected disproportionately.
This variability and lack of advance notice make it almost impossible for hourly workers to schedule other shifts or income streams around their main job in an effective manner. When hours vary significantly, pay does too, creating an unpredictable and irregular income, which many workers need to smooth and/or bridge when expenses come due.
Income smoothing can be accomplished through a number of financial services but the problem is further compounded by the fact that these same workers are disproportionately unbanked or underbanked. ~31% of households whose income varied a lot were underbanked, compared to just ~19% of households with steady income according to the FDIC – nearly a 62% higher incidence! In practice, this means that while underbanked households use a bank for a checking or savings account, they have to go outside of the banking system for other financial services like money orders, check cashing, and payday loans.
Why, one might ask, do these people look outside the system for access to capital? For starters, limited or poor credit history limits avenues by which underbanked customers can access capital. According to the Center for Financial Services Innovation, 42% of underbanked customers could not be scored based on thin or no credit history, while another 33% were considered subprime. This closes off many traditional avenues to capital, forcing underbanked Americans to turn to alternative financial services.
As the only game in town, and with decreasing checks on interest rates that they are allowed to charge, payday lenders provide workers with the financial bridge they need at predatory rates that can average as high as 400% APR according to the Center for Responsible Lending.
This begs the question – what can be done to fix this problem from both a business and policy perspective?
From a business standpoint – there are a few intriguing options. The first is offering more immediate access to earnings and the second is allowing workers to borrow against future earnings based on their history and performance.
Traditional employers would do well to follow the income flexibility that platform companies have been rolling out. A great example is Uber’s Instant Pay feature, which allows workers to cash out accrued earnings as often as five times a day. Giving workers more immediate access to capital helps them smooth earnings by cashing out when they need money and getting paid nearly immediately for the work that they’ve done. It’s often the bridge of having expenses due and waiting for the bi-weekly paycheck to clear that powers a good chunk of the payday loan industry.
Businesses can go further as well. In an era of increasing competition for quality workers – new incentive structures and financial perks can be a powerful driver of talent attraction and retention. One such perk can be to offer micro-loans directly to employees themselves. Given that the average payday loan term is ~2 weeks and range from $100-$1000, employers can offer low-interest loans directly based on historical work and average earnings. If workers know they can both access their earnings faster and borrow against their past and future shifts – it increases the commitment of their work and massively reduces any dependency on payday loan structures.
A lot can be done to help alleviate the problem from a policy perspective as well, and some highly creative solutions have been proposed. Most recently, Senator Kirsten Gillibrand’s proposal to offer basic financial services across United States Postal Service (USPS) locations, including short-term loans, would help serve many Americans who can’t currently access these services affordably, or even conveniently. According to a USPS Inspector General report, 38% of Post Office locations exist in zip codes with no bank, and another 21% in zip codes with only 1 bank. While Senator Gillibrand’s proposal to offer small loans at Treasury bill rates seems highly infeasible, the same report estimates being able to offer loans at a 25% interest rate – a far cry from payday lender’s 400% APR. This is an incredibly creative solution and has started to garner support amongst leading democrats. Leveraging the vast retail presence of USPS locations as de-facto banks to serve the underbanked is a powerful way to create a public option for small banking needs. By increasing the APR these locations would charge to make this a self-sustaining (or even profitable) program, the USPS could build another revenue stream and the government have created a solution that is nearly 10 times more effective in helping bridge the loan gap than current predatory solutions.
Further regulation on payday lenders, regulation that was set to go into place in January and was suspended indefinitely, could also curb more exploitative practices. The legislation would have required lenders to reasonably determine an “ability to repay the loan” and would have also restricted lenders of longer term, high-interest loans from auto debiting from a consumer’s account without their consent. More common sense regulation that limits the influence of payday lenders is needed to help protect the American worker – a class of voter that both parties want to champion.
Finally, policymakers should also consider tax breaks and incentives for corporations that do leverage their balance sheet and create short-term loans for their employees or implement same-day payments. Working capital and cash management are real corporate concerns and the ability to write off bad debt from loans to workers or get yearly tax breaks can be a powerful carrot to influence this change.
The need for change is clear and American business and policymakers can come together to create a solution that structures loans as a way to profitably lend a hand in time of need, not as a predatory clamp that pushes workers into the ultimate debt trap.
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