Substantive regulation of consumer credit generally has one intended effect and three unintended consequences. The good effect is less of whatever it is that is regulated. So if regulators cap interest rates through usury regulations, for instance, interest rates on average will be lower. But there are also unintended consequences: (1) term repricing (i.e., substitution of up-front fees like annual fees, downpayments, or points), (2) product substitution, such as less use of the regulated product (such as credit cards) and more use of alternative products (such as layaway or payday lending), and (3) if term and product substitution is not perfect, there will be credit rationing. The basic question for regulators, then, is whether once the benefits and costs of the regulation are tabulated, do the overall benefits exceed the costs.
Jonathan Zinman of Dartmouth has an interesting new paper out on the effects of payday lending regulation in Oregon that looks at these factors. Here’s his findings (as summarized in the abstract):
Many policymakers and some behavioral models hold that restricting access to expensive credit helps consumers by preventing overborrowing. I examine some short-run effects of restricting access, using household panel survey data on payday loan users collected around the imposition of binding restrictions on payday loan terms in Oregon. The results suggest that borrowing fell in Oregon relative to Washington, with former payday loan users shifting partially into plausibly inferior substitutes. Additional evidence suggests that restricting access caused deterioration in the overall financial condition of the Oregon households. The results suggest that restricting access to expensive credit harms consumers on average.
And in the paper he fleshes out some of the substitution effects–the substitution effect for payday lenders seems to be primarily for checking overdraft protection and late bill payments (presumably in preference to bounced checks) along with some residual rationing effect:
I find that the Cap dramatically reduced access to payday loans in Oregon, and that former payday borrowers responded by shifting into incomplete and plausibly inferior substitutes. Most substitution seems to occur through checking account overdrafts of various types and/or late bills. These alternative sources of liquidity can be quite costly in both direct terms (overdraft and late fees) and indirect terms (eventual loss of checking account, criminal charges, utility shutoff). Under the broadest measure of liquidity in the data, the likelihood of any expensive short-term borrowing fell by 7 to 9 percentage points in Oregon relative to Washington following the Cap. This jibes with respondent perceptions, elicited in the baseline survey, that close substitutes for payday loans are lacking.
Next I examine the effects of the Cap on the summary measures of financial condition that are available in the data: employment status, and respondents
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