US Moving to Ban Microcredit

23 October 2006 at 10:50 am 7 comments

| Peter Klein |

Larry White asks an important question: Given the near-universal enthusiasm for microcredit, why is its US equivalent — the payday loan — constantly under fire? Payday loans, cash advance loans, check advance loans, and the like are small, short-term, high-interest loans, typically offered to low-income, credit-constrained consumers. As Larry points out, the 2007 National Defense Authorization Act, signed last week by President Bush, includes a 36% interest-rate cap on payday loans made to military personnel; there are calls to extend such a cap to all payday loans in the US, which would effectively shut down much of the payday-loan industry.

Of course, the typical payday-loan consumer in the US is not an entrepreneur seeking capital to start a new venture, but a low-income consumer without savings or credit cards trying to pay the rent, make a car payment, or even buy groceries. Still, the basic principles are the same. Payday loans are high-risk, uncollateralized loans, and naturally carry higher interest rates than conventional secured debt. They provide credit to individuals who are otherwise unable to acquire funds. Grameen Bank defends its interest rates — typically 25 to 50 percent annually — on the grounds that the alternatives facing borrowers are even worse. Wouldn’t the same apply to payday lending?

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7 Comments Add your own

  • 1. Lars Smith  |  23 October 2006 at 1:35 pm

    Thomas Dicter says that “The little serious research we do have on microcredit’s impact shows that it helps poor people bridge cash flow gaps in their consumption cycle, and it can give more confidence to women”. Microcredit is probably a lot more like payday loans than commonly acknowledged.

    The reference is here,

    http://conservationfinance.wordpress.com/2006/06/26/microcredit-hype-and-hope/

  • 2. Peter Klein  |  23 October 2006 at 1:41 pm

    Lars, thanks for the reference.

  • 3. Microcredit and Payday Loans « Conservation Finance  |  28 October 2006 at 8:49 am

    [...] Microcredit loans help smooth out fluctuations in income, maintain consumption levels during lean periods, and provide buffers against sudden emergencies. As such they are extremely useful, but much more like payday loans than venture capital investments. [...]

  • 4. NOTGIVEN  |  13 May 2007 at 9:27 pm

    I have served as a branch manager for one of the leading providers of Payday Advances for the past 10 months.

    There are many opponents and proponents to my industry, who all have justified reasons for their positions. My position is that Payday advances do serve a need to a public that desperately searches for alternative lending options.

    The fact remains that a one-time payday advance is less costly than current alternatives. For example; a typical Alabama family who lives paycheck to paycheck, may come up short on groceries between paydays. This family may write a $100.00 check for groceries, even though they do not have the money in their account. This family knows that they have overdraft protection on their checking account, which will cost this family at least $30.00 in NSF fees, depending on which bank they use. This family would benefit from a payday loan because the fee for a $100.00 loan is only $17.50.

    The problem that exists and I am using my own store as an example, is that over 95% of consumers that originally take out a payday loan, continue to use the service repeatedly. It becomes almost an addiction or a trap that is just too difficult to overcome.

    I have a customer that originally took out a $200.00 loan in November of 2003. This customer is paid bi-weekly and has had an active payday loan ever since this date. The total fees paid since during this time, $6353.52. This example represents the vast majority of my current customer base. This is where the problem lies

    The company I work for is very good about making the consumer aware that Payday loans are not a long-term solution but rather a short-term fix for unexpected expenses or income gaps between paydays. However, with most family’s living payday to payday, completely paying off a payday loan in a short time period is all but impossible.

    To sum it up, it is my firm belief that Payday Loans can be a great service for consumers that run into a problematic situation between paydays. However, I also believe that more strict regulation is necessary.

  • 5. Marcin Tustin  |  15 May 2007 at 5:10 am

    I wonder: would there be lender or borrower interest in relatively low value secured revolving credit facilities: e.g. $300 secured on a car?

  • 6. Charlie  |  20 November 2009 at 9:05 am

    Interesting what it will result in. Let’s see.
    Maybe we ban all kind of credits? Do you think it will solve the problem?

  • 7. Brenda van Niekerk  |  19 February 2010 at 5:32 am

    The fact that payday loans are constantly under fire makes one realize that loan companies should be scrutinized and more legislation laid down to protect borrowers who do not realize how high the interest rate is and how easy it will be to fall into debt

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