UNSW UNSW Business School UNSW Business School

Curbs on payday lending can improve public health

May 16, 2017
Social impact

A study finds restrictions reduce impulsive alcohol purchases

To its proponents, payday lending provides short-term cash to people to meet urgent needs, especially those who are unable to get loans elsewhere. 

But to its detractors, payday loans aren't about meeting urgent needs. They argue it preys on the vulnerable, selling them loans they don't understand and charging them extremely high interest rates.

Recent research by Christopher Gibbs, a lecturer in the school of economics at UNSW Business School, suggests that at least some of the time, payday loans aren't always used to meet pressing needs.

In the paper, The effect of payday lending restrictions on liquor sales, Gibbs and his colleague Harold E. Cuffe from Victoria University in New Zealand, tested the effect of short-term loans on alcohol store sales.

They examined what happened to alcohol sales in the US states of Washington and neighbouring Oregon after Washington introduced restrictions on payday lending in 2010.

The law limited the size of a payday loan to the lower 30% of a person's monthly income, or US$700, whichever was less. It created a state-wide database to track the issuance of payday loans in order to set a hard cap on the number of loans an individual could obtain in a 12-month period to eight, and eliminated multiple concurrent loans.

Finally, the law mandated that borrowers were entitled to a 90-day instalment plan to pay back loans of US$400 or less, or 180 days for loans of more than US$400.

The law had a rapid effect on the payday lending sector. The number of payday lenders in Washington state dropped from 603 to 420 in the first year and to 256 the year after that. During the two years, total loan value dropped from US$1.366 billion to US$330 million.

After the Washington restrictions came into effect, liquor store sales fell an average of 3.6%. However, those liquor stores that were located close to payday lenders suffered a 9% decline in sales.

"The finding is significant because it shows that payday loan access is associated with unproductive borrowing, and directly links payday loan access to public health," the authors write.

They also found that reducing access to payday loans did not reduce general household expenditure.

'Payday lending gives people the means to satisfy impulses that they probably already have' 

– christopher gibbs

Sudden liquidity

Gibbs says that while people don't necessarily borrow from payday lenders with the express intention of buying alcohol, that can be the result.

For instance, someone may walk out of a payday lender with $400 they borrowed to fix their car, but they may only need $300.

"You still paid for your car, but because you've had this infusion of liquidity which you didn't have before, you now decide to make other purchases that maybe you hadn't thought about making before," Gibbs says.

"And so, it's more [a case of] impulse spending when you're all of a sudden flushed with cash."

People often use injections of liquidity such as tax refunds for impulse purchases, says Gibbs. The problem with payday loans is they can leave people worse off and with less capacity to borrow when they have a pressing need for funds.

"Payday lending gives people the means to satisfy impulses that they probably already have – and [in] satisfying that impulse using funds which carry with them a 700% annual percentage interest rate, that's probably not the best way to use those funds," says Gibbs.

He suggests people may rethink their borrowing and what they spent the proceeds on if they realised they could pay up to 700% interest on that bottle of whisky.

The Washington law reform was "probably the right way to go about it", he adds. By capping the number of times somebody can take a payday loan, Washington is still allowing people access to the loans if there really is an emergency. But at the same time it will cut down on the bottle of whisky with a punitive interest rate.

Higher hurdles

Payday lending is a rapidly growing market in Australia.

According to a March 2015 report by the Australian Securities & Investments Commission (ASIC), the overall value of small-amount loans written for the 12 months to June 2014 was close to $400 million, an increase of about 125% since 2008.

Even with the increase, payday lending represents only about 0.4% of the total consumer credit market in Australia.

As with Washington state, the government in Australia has cracked down on payday lending.

Under reforms that took effect in 2013, establishment fees were capped at 20% of the amount of credit and monthly fees at 4%. Lenders were prohibited from lending money to people who were in default on another small-amount loan or who had already taken two loans in the past 90 days.

Credit contracts for $2000 or less that have a term of up to 15 days were prohibited. (For this reason, lenders argue that the term 'payday' loans is now misleading, though it remains in common use.)

There is also a requirement that consumers who default under a small-amount loan must not be charged an amount that exceeds twice the amount of the loan.

"There's a much higher hurdle that lenders have to jump now to provide these small-amount credit contracts and that has led to people exiting the industry and it has led to improving standards by those that have remained in the industry," says Paul Walshe, a board member of the National Credit Providers Association, the industry representative body.

Walshe, who is also the founder of small-amount loan company Fair Go Finance, says that taken together the 2013 reforms are tough enough to prevent debt spirals and that it is not in lenders' interests to loan money which can't be repaid.

In 2016, following an intervention by ASIC, Fair Go Finance paid $34,000 in infringement notices for overcharging interest and establishment fees on its Flexi-Loan product. In cooperating with the regulator, the company also refunded around $34,500 in interest and fees to approximately 550 borrowers.

'I do see evidence of consumers getting payday loans which are funding kind of addiction-type behaviours' 

– Alexandra kelly

Credit entitlement

Walshe says he was surprised at the linking of US research into the drivers of alcohol sales to the Australian small-loan market, but notes that it appears both lending markets went through similar structural change after regulation changes.

"As a lender, you need to get 90 days' bank statements for each small amount credit contract that you provide. The consumer's spending habits are displayed on those bank statements. If you're reviewing those bank statements appropriately, then you should be able to detect customers who have a high propensity for buying a lot of alcohol," he says.

But Alexandra Kelly, a solicitor with the Financial Rights Legal Centre, believes the changes don't go far enough and vulnerable consumers are still being exploited.

She says she presently has a client who has taken out eight payday loans in the past month, despite the 2013 reforms, funding a lifestyle he can't afford and digging deeper into a cycle of debt.

"I do see evidence of consumers getting payday loans which are funding kind of addiction-type behaviours, whereas if they just didn't have the credit and didn't have access to funds, they probably would have been better off," she says. "I am certainly not of the view that everyone is entitled to credit."

Kelly says she gets anecdotal feedback from clients that payday lenders tell them what to write on their application forms, getting around provisions that require the loans to be for a specific purpose.

She also notes that the profile of payday borrowers is changing, with more middle-income earners with stable incomes accessing the loans as payday lenders advertise in the mainstream media and "normalise" the behaviour.

The Financial Rights Legal Centre and other consumer groups are seeking further restrictions on small loans, including restrictions on how much of their income social security recipients can spend on payday loans to leave the rest of their income for day-to-day living expenses while not denying them access to finance if they need it.

She would also like to see a 48% cap on the total interest a payday lender can charge a borrower. 

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