Payday Loans

People get into financial trouble, with reasons varying from simple overspending, recurring
expenses to emergency healthcare expenses in their lives. Most people resort to borrowing money from
family members, banks, credit unions and credit cards etc. But people with inadequate credit worthiness
who cant qualify for credit at big banks or for easy convenient quick cash needs might resort to the
payday loans for funds needed in the short term. A payday loan, also known as direct deposit advance
(Chris Morran, 2012) or check loan, is a very high cost, unsecured, small amount, short-term personal
loan that is typically due on ones future pay check day. Almost all lenders charge a fixed percentage
interest, typically a $15 to $30 charge on a loan of $100 over a two week period representing a nominal
percentage rate of 390% - 450%, on the principal of the loan. The effective annual rate considering
compounding, would be a very high 3685% interest on the loan. By comparison, interest rates on credit
cards can range anywhere from about 12 percent to 30 percent depending on the borrowers credit
worthiness.
Payday lending, now a $46 billion industry, emerged in the 90s with minimal state regulations on
the lending practices to the point that there are about 21,000 payday lending institutions in the US (legal
in 35 states only), more than the number of McDonalds and Burger King restaurants combined
(Newsom, 2010). In response to the expansive complaints from consumers, Federal and State
governments have started regulating the industry on factors such as how much one can borrow and the
fees that are charged on the loan. Some states do not have any payday lending storefronts because these
loans are not permitted by the states law, or because lenders chose not to do business in a state rather than
abide by the states regulations. According to most US payday loan regulations, the principal amount lent
cannot exceed $1800, although most loans are around $300 to $500. Lenders typically allow loans up to
50 percent of the next pay check, but more often they are between 15 to 30 percent. As of September
2015, a quick fact check on Texas State law revealed that the state allows up to 20% or $1800 of the pay
check, maximum interest rate for payday loans range from 83.43% for a 30-day $350 loan to 569.92% for
a 7-day $100 loan, and there are no criminal rights for the lender if a person goes into default (Texas
State, 2013).

Borrowers who are not able to repay their loans before due date usually have three options:
either (1) to extend or rollover the loan to a new loan with new terms; or (2) to pay off the loan (if
needed, pay off the prior loan with another loan taken immediately from the payday lender through a
back-to-back transaction); or (3) default, and thereby incur bounced check fees by the payday lender
and insufficient fund fees by the borrowers bank while still owing the full amount of the original
post-dated check. The major issue with rollovers and back-to-back loans is that they would incur the
repeated application of loan origination fees and other setup fees for each such new loan. Borrowers
who, cannot barely meet their ends with their paycheck for medical emergencies, utilities or personal
reasons, avail the payday loan with high interest can quickly fall into a vicious debt cycle that they
cant get out easily making it often impossible to repay the principal in all. The ethical question here
arises - Doesnt the payday industry have a moral corporate responsibility to treat financially
vulnerable people as ends in themselves rather than merely as a means to an end? (Kant, 1964).
According to Schwartz and Carroll, activities would be deemed unethical when they are: (a)
amoral in nature (i.e., with an unawareness or indifference to the morality of the action); (b) take
place despite an awareness that the action conflicts with certain moral principles (i.e. trustworthiness,
accountability, caring, and responsibility towards society etc.); or (c) are only intended to produce a
net benefit for the corporation and not for the affected stakeholders (Carroll, 2003). A study
conducted by the Wisconsin Department of Financial Institutions concluded that payday loan
borrowers commonly rolled over their loans or obtained subsequent extensions of credit; over 42
percent of the borrowers had taken between six and fifteen payday loans within one year (Hodson,
2003). Although some U.S. States ban rollover loans, payday lenders allow customers to make backto-back loans, which are simply a renamed version of rollovers. These statistics indicate that, at
least from a customer stakeholder perspective, the payday loan industry operates primarily with a
strong emphasis to maximize profits or shareholder value and is partly, in the legal domain, but is not
ethical. There can be various complaints against payday lenders, but most of them revolve around the
fact that most of their customers are relatively poor and fall prey to the cyclical debt trap due to the
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high interest rate. Another argument is that pay lenders setup shops targeted at communities where the
familys average incomes are less than $50,000, or there are more people who are unemployed,
underemployed, credit constrained, less educated or are from Hispanic or African American ethnicity.
Payday loan advertising in these neighborhoods are attracting youth and young couples to taken on
personal debts to indulge in petty things otherwise not affordable to them. Critics contend that payday
borrowers are not well informed about the true cost of their borrowing costs and that lenders engage
in deceptive practices, specifically practices designed to encourage repeat loan rollovers.
But on the other hand, an action is considered ethical when it promotes the good of
society, or more specifically, when the action done right way is intended to produce the greatest net
benefit (or lowest net cost) to society when compared to all of the other alternatives (Carroll, 2003).
The benefits of the industry to society can be identified in terms of the number of users of the service,
and the short term alleviation of hardship with easier and quicker access to funds can provide. Many
customers would potentially not be able to obtain short term credit but for the payday loan industry.
In addition, proponents of the Payday lending business argue that the main problem point is not the
industries lending practices but the Borrowers inability to paying off the loan on time. On frequently
defaulting and or rolling over the loan they bring those additional fees and interest onto themselves.
They would argue that there are few other merits that is positive to the existence of the industry. (1)
Payday lenders provide microfinance to low income and limited-credit worthy people, who have
exhausted all other credit alternatives, at all unbanked and underbanked locations. Approximately 7.7
% (~ 9.6 million households) are unbanked and 20% of all U.S. Households (~ 24.8 million people)
are underbanked (FDIC, 2013), meaning that they had a bank account but also used alternative
financial services such as payday loans, pawn-shops, non-bank issued money orders etc. Such
consumers could potentially be forced to illegal sources if not for payday loans. (2) A study by the
FDIC Center for Financial Research (Samolyk, 2005) found that the pay day loan is a high risk
business, the "operating costs are not that out of line with the size of advance fees" collected and
that, after subtracting fixed operating costs and "unusually high rate of default losses," payday loans
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"may not necessarily yield extraordinary profits.". In comparison the author of that article concludes
that the charges and additional fees that cover their operating costs and liabilities are in line with other
big banks/credit card businesses that charge 25-40%. (3) In a profitability analysis study by Fordham
Journal of Corporate & Financial Law (Law, 2007), it was determined that the average profit margin
from seven publicly traded payday lending companies (including pawn shops) was 7.63%.These
averages are less than those of other traditional lending institutions such as credit unions and big
banks (e.g. Capital One, GE Capital etc.) whose average profit margin was 13.04%. (4) A study
by Professor Adair Morse found that in natural disaster areas where payday loans were readily
available, consumers fared better than those in disaster zones where payday lending was not present
(Morse, 2009). Not only were fewer foreclosures recorded, but such categories as birth rate, crime
rate were not affected adversely by comparison. (5) A study by The Pew Charitable Trust (The Pew
Charitable Trusts, 2012) showed that most borrowers use payday loans to cover ordinary living
expenses and not unexpected emergencies (Blatt, 2012).(6) Pay lending businesses contribute to
creating jobs and benefiting employees, suppliers and support governments and society with tax
revenue. These statistics indicate that, from a payday industry perspective, the payday loan industry
clearly is not just making large profits as expected, is legally operating, and helping borrowers in hour
of need thereby indirectly helping the society. The question that arises here - Though the payday
industry is legally operating, is it morally operating with transparency and accountability.
One way to analyze both side of arguments is to assess the net benefit to the society. While
users of the payday loan service clearly derive a short term benefit, the debt trap also may add up to
other social costs such as bad credit ratings, lower savings rates, less home ownership, bankruptcies,
an increase in the number of people depending on welfare, and the costs of preventing and deterring
criminal behavior (Butler and Park, 2006: 123). One can conclude that if a long-term perspective is
taken, the industry is not clearly generating a net benefit to the society, and would need the payday
industry to act on reducing the fees. Opponents to Payday lending and few state governments
proposed a complete ban on this industry all together or at least highly regulate them in such a way
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that these businesses cannot collect an exorbitant interest rate and make large profits. In such a
scenario several questions arise such as: Would society be better off if the entire industry ceased to
exist? Would other financial institutions (e.g., big banks, credit unions, etc.) ever step up to fill in the
need for payday lenders? Are payday lenders operating in the most efficient fashion by charging
excessive rates, or could they survive and even prosper while reducing the rates they charge to a more
reasonable level? Were any alternatives to these lending options explored? From the financial
references in the paragraph before it is highly unlikely that the big banks would take the initiative to
go the extra mile to serve these borrowers with such thin margins and government regulations.
Based on the arguments so far, it looks imperative that there are sections of people in crunch
times and in certain demographics who need access to short term funds via alternative financial
institutions. So, with the acceptance that these services are indeed needed and utilized, the
government and businesses need to take steps to present consumers and society as a whole with
offerings in an equitable way, fair to both lenders and borrowers. The government needs to encourage
more microfinance lenders in the market to thrive but at the same time should not bog down the
industry with additional regulations to provide justice for few peoples financial mismanagement.
Even if the federal and state governments enact laws and policies that may cause payday lenders to
close shop in the interim, it wouldnt make demand disappear altogether, borrowers in need of quick
cash may just go across jurisdictions or turn to even more risky sources, such as the Internet or money
launderers etc. For example, When Virginia State lawmakers cracked down on payday lending by
limiting borrowers to one payday loan at a time, and doubled the length of time they had to pay the
money back, payday loans plunged more than 80 percent. A few lenders closed shop, some disguised
themselves and created a new form of short-term lending: car-title loans (Guo, 2015). Following 2007
financial credit crisis the economic hardships of some financially weaker sections made Payday loans
an intensely debated subject in political machinery. More recently, Payday lending became a hot topic
of conversation following President Barack Obamas speech on Payday Loan rules proposed by
Consumer Protection Agency at Lawson State Community College on Mar 26 th 2015. The new
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regulations would not ban the payday lenders but indeed require lenders to make sure that borrowers
have the means to repay them and curb the lenders to be able to make a maximum of six loans to a
borrower in a year. In addition to those, fifteen states in the US, have capped the APR charged to 16
percent to curb exorbitant lending charges and mandated that all consumers that take out one of the
loans need to be made fully aware of all of the risks that come with them, what all of the costs are,
what the interest rate is, and how much the interest rate could accumulate over time (Emily
Stephenson and Julia Edwards, 2015). This consumer education mandate will ensure that the
borrower is aware of everything and is not caught by surprise. In addition to the regulations, it is very
much important that each business in the payday lending industry needs to compile their Code of
Ethics or at least model it over Financial Service Centers of America (FiSCA) Code of Ethics at the
highest moral level and strictly adhere to it, not simply because of external pressure or because
everyone is doing it (Payne, 1990) but for the greater good. Some of the major ethical guidelines
that the industry need to follow in the process are to (a) always take into account and check if it is
doing the right thing, in right way and for the right reasons (b) encourage consumer responsibility,
(c)engage in consumer financial literacy education, (d) disclose loan terms in full, (e) craft alternative
repayment place for those in default, (f) train employees to recognize and discourage cycle of debt,
(g) proper documentation check, (h) disclose domicile of company, (i) limit the use of rollovers that
unfairly retain debtors, (j) comply with local laws (k) use appropriate collection practices, and (l)
promote ethical conduct and corporate culture etc.
In conclusion, the author is of the view that the existing laws and proposed payday lending
rules do not go far enough for the collective welfare of the society. Given the increase in payday
lending activities all around the country, it is clear that Payday lenders provide a service that
consumers need and for which consumers are willing to pay for. Thus, certain policy measures rather
than legal regulation may be effective and valuable means by which payday lenders can continue to
operate, but to do so with less intense scrutiny and a more positive image. Only when the industry

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adopts and implements their own codes of ethics and best practices, they can assure the ethical
practice of business to the benefit of themselves, their consumers and society as a whole. Only after
such changes take place, the overall greatest net good for society will be realized.

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References
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