Banks should enter payday lending market, says Auburn University finance professor

Published: June 27, 2018
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Auburn University finance professor John Jahera says banks should offer payday loans because of Americans’ easy access to bank branches and to help unbanked people establish a relationship with a bank and to build a credit score. Below are questions that Jahera can answer.

Why do banks not engage in payday lending activities?

Jahera: There are a couple reasons why many banks do not engage in payday lending. First, the low dollar amount of such loans, typically $300 to $500, does not always generate enough profit for banks. Second, bank regulators until very recently have frowned upon such lending as predatory and, in fact, Operation Chokepoint was a program to discourage firms from entering certain businesses deemed unfavorable. Bank regulators wanted banks to do complete underwriting to assess a borrower’s ability to repay. Such a credit investigation is simply too costly for such a small loan. The Consumer Financial Protection Bureau had proposed such rules, but, under the current administration, those rules will likely not be implemented.

Do we need payday lending in the U.S.?

Jahera: Payday lending shows high demand. In Alabama, once mandatory reporting was adopted, the number of such loans per week was around 42,000. So it is clear that demand for small dollar, short-term loans is there. The question is how best to meet that need.

What about the high rates of interest on payday loans and are they predatory?

Jahera: Interest rates are indeed high when measured on an annual basis. But the rates reflect the high risk nature of such loans. One advantage a commercial bank would have is a much more diversified loan portfolio so losses could be spread around the various loans. Opponents of payday lending often refer to the industry as predatory…that is, preying up on the less fortunate. Research has shown that such stores tend to locate in less economically prosperous areas. While the research is mixed, some have found that areas with large African American populations have more payday lenders. Of course, the industry would argue they are simply going to where the demand is.

Should banks enter that market?

Jahera: Yes, in my view it would be good on many fronts. First, we still have a large number of bank branches around the country. Second, this would enable unbanked people to establish a banking relationship that could help them build a credit score and perhaps open the door for other banking services. Keep in mind that the rates though on such loans will still be high relative to secured loans given the higher risk nature. So we should not expect to see a dramatic drop in the rates on such loans.

About John Jahera:

Jahera serves as the Bobby Lowder Professor of Finance in Auburn’s Harbert College of Business. He is the author of more than 80 articles in a variety of academic and professional journals including the Journal of Financial Research, the Journal of Law, Economics & Organization, Research in Finance, the Journal of Real Estate Finance & Economics and the Journal of Banking & Finance. The primary focus of his research has been in the area of banking, corporate finance and corporate governance. He serves as co-editor of the Journal of Financial Economic Policy and is on the editorial board of Corporate Finance Review, Review of Pacific Basin Financial Markets & Policies and International Journal of Business & Finance Research.

Interviews:

To arrange an interview with Jahera, please contact Preston Sparks, Auburn University director of communications, at 334-844-9999 or pjs0027@auburn.edu. A photograph of Jahera is available at https://flic.kr/p/28n2mTr.

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