The discussion of payday loans has been particularly loud recently, in both the United States and the United Kingdom. U.K. officials have notified all lenders that there will be more scrutiny of the sector in the future, and more U.S. states are looking into banning payday loans altogether, on top of the 18 that have already done so. But, as one American Banker article explains, governments are forgetting about the value of payday loans, and banning them could create an even worse situation for borrowers.
Most often, payday loans are critiqued for their high interest rates. However, low interest rates are not a result of legislatures forcing rates down, but is instead the effect of increased competition and innovations. By forcing these options out of the lending sector, not only are legislatures keeping borrowers who may not be able to take out other types of loans from a payday loan, with decreased competition, other lenders know they have the option to increase overdraft fees or interest rates – hurting a borrower much more than with the original payday loan.
Another reason to avoid shutting this industry down is that it is not new – payday loans have existed for more than 20 years, and borrowers continue to utilize this form of lending. If it was as dangerous as some legislators are making it out to be, as one Columbus Dispatch article explains, “the customer pool would have dried up long ago.”
Recent technology, including risk management tools, have helped lenders better detect the amount of risk involved by using alternative data. With more information regarding a borrower’s history – even a nontraditional borrowing history – payday, and other lenders, are able to cut down on interest rates, with more knowledge about the risk. Instead of requiring that lenders either exit the market or lower the rates, investing in these tools may prove to be a wiser decision, and provide more stability to those who turn to these types of loans.