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' qualitative assessments of recent and future financial situations. Estimates on individual outcomes are noisy but consistent with large declines in financial condition. Estimates on a summary measure of any adverse outcome—-being unemployed, experiencing a recent decline in financial condition, or expecting a future decline in financial condition— suggest large and significant deterioration in the financial condition of Oregon respondents relative to their Washington counterparts. As such the results suggest that restricting access harmed Oregon respondents, at least over the short term, by hindering productive investment and/or consumption smoothing.
This finding is interesting for a couple of reasons. First, a number of researchers have observed that despite the "high" APR on payday loans, the cost of a payday loan is probably less than the cost of bounced check once the returned check fees are taken into account. It looks like there is some evidence that consumers are using payday loans (and related products like overdraft protection and late bill payments) to prevent bounced checks. Second, some research has suggested that many consumers who are unable to gain access to payday loans they generally turn to pawn shops as the next-best substitute. Zinman finds in surveys that about 15 percent of respondents report that if they were unable to get a payday loan they would have turned to something like a pawn shop, car title loan, or credit card (there is some evidence that consumers use payday loans even when they could use credit cards for some reason). So overdraft protection loans, Zinman suggests, are closer and less-inferior substitutes for payday lending.