State Regulation of Traditional Payday Lending Spurring Growth in Online Payday Lending

So it turns out that simply eliminating the supply of payday lending doesn’t actually eliminate demand.  Who would’ve thought it?  According to this story (which simply reports what has already been known to be the case), whenever state laws eliminate bricks-and-mortar payday lending many of those consumers simply substitute to online payday lending.  Indian Tribes are becoming an especially attractive base for online payday lending operations.

In general, of course, more competition is better than less, and so I fully support the right of online payday lenders to compete with traditional bricks-and-mortar operations.  On the other hand, as noted in the article, online payday lending raises several novel regulatory concerns.  For example, as I understand it, rather than writing a post-dated check, online payday lending often works through a borrower giving the lender direct access to his bank account to make an EFT, which can raise heightened concerns about privacy and security.  Moreover, despite their lower operating costs, to date online payday lenders do not appear to offer rates noticeably lower than bricks-and-mortar businesses.  This could be for several reasons: adverse selection, heightened default risk (because of lack of legal enforceability), or reduced competition because of the fact that many online borrowers lack easily-accessible offline options.  In the medium to long run, however, I suspect that online payday lending is a useful pro-consumer innovation and would grow over time, even without the subsidy provided by legislators regulating out of existence their leading source of competition.

More generally, the point here is obvious: while competition and free choice is good, enacting well-intentioned but misguided regulations that eliminate consumers’ preferred options and push them to less-preferred options is not a strategy well-designed to increase their welfare.  You simply cannot wish away consumer need for credit, even short-term high-cost credit.  And while state regulations enacted on the misguided premise that we can wish away that need has proved a boon for Indian Tribes and online lenders I fail to see how payday loan customers are better off as a result of this substitution.


I received a few useful comments from a lawyer who expert in all types of payday lending.  He offers a few corrections and elaborations to some of my observations:

1.  Regarding “heightened concerns about privacy for ACH debits, the information necessary to initiate an ACH debit entry to a person’s checking account is the same information that is encoded on the bottom of his check–the routing number and account number, nothing more, and has no more “private” information than the possessor of an unsigned black check from the borrower’s account.  The ACH process is also extensively used by brick-and-mortar payday lenders to collect past-due loans for reasons for speed and simplicity.  The cost of doing so is also lower than the cost of presenting the physical check; bank charges for a returned ACH debit are generally a small fraction of such charges for a returned check–this despite the current practice of banks under the Check 21 Act to present nearly all checks electronically.

2.  There is a huge, and rapidly-growing, Internet-based lending business, both for payday and auto title.  Indian tribal sovereign immunity is only one of the models.

3.  In general, the price of an Internet payday loan is, as you point out, higher than the price of a comparable brick-and-mortar loan.  There are several reasons for this.  First, with immaterial exceptions, every state that permits payday lending has a regulated price ceiling.  As a general matter, the regulated ceiling is below the equilibrium price.  The Internet is generally free of these strictures, price discovery is simple, and the equilibrium price unsurprisingly winds up as the market rate.  Second, the lender’s highest costs on the Internet are not credit losses but rather the costs of borrower acquisition that involve payments to third parties….  Lead generation is itself a huge and profitable industry.  Third, credit losses are indeed somewhat higher with Internet loans but insufficiently higher to explain the price differential.

This is all very helpful.  I find point 3 especially interesting in that it reminds me that payday loan storefronts are themselves a type of advertising, much like the ubiquity of Starbucks stores not only enables them to sell a lot of coffee but also serves as a type of advertising for the chain more generally.  At the same time, this advertising function is embedded in the overhead.  Online payday lending, of course, lacks that attribute so it follows that they would have to use alternative marketing devices.  I’m intrigued by the “lead” business for Internet payday loans if anyone knows more about that.

Also, it sounds like there is indeed some adverse selection with respect to Internet lenders as at least some of those who borrow have been rationed out of traditional bricks-and-mortar price controls.  Adverse selection might also contribute to the higher default rate online if collection is more difficult because of legal restrictions and difficult in enforcement.

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