Urban place-making centred on equity and social justice
Introduction: What are payday loans?
Payday loan is a form of alternative financial service that provides short-term cash loans upon the guarantee of a postdated cheque or pre-authorized debit payment (Spotton Visano, 2008). In Ontario, 400,000 payday loan transactions happen every year in 796 licensed payday loan establishments, issuing $1.1 – 1.5 billion in payday loans annually (Deloitte, 2014). Payday loan borrowers are typically excluded from other sources of financial credit and use payday lending services because they cannot or do not want to access traditional cheaper financial services (ACORN Canada, 2016). However, payday loans have extremely high interest rates in exchange for its quick and convenient cash flow. To illustrate, Ontario’s Payday Loan Act currently permits up to $15 interest for every $100 in loan, which amounts to an annual percentage rate (APR) of 390% (Province of Ontario, [the Province], 2018). This business model puts payday loan borrowers, most of whom are plagued by low income, in financially vulnerable situations (Edmiston, 2011; Koku & Jagpal, 2015; Deloitte, 2014).
Recent changes to the Payday Lending Act give municipalities the authority to regulate local payday lending establishments in regards to number, location, and licensing (City of Toronto [the City], 2018). However, as pointed out by ACORN, an anti-poverty organization, payday lending is a symptom of poverty (The City, 2018). Therefore, payday loan regulations should be seen as a partial contribution to a broader policy project to provide more secure and affordable financial services to those who currently rely on payday loans.
In our increasingly financialized and urbanized economy, financial inclusion has become an indispensable component to one’s ability to participate in the mainstream economy (Spotton Visano, 2008). Therefore, in addition to regulating the payday lending industry, the City and the Province should also work to legally guarantee non-discriminatory access to secure and non-predatory financial services for residents (Gershman & Morduch, 2011). Informed by this framework, I first examine why the demand for payday loans exist in the first place and explore which financial service gaps they fill. Then, I review regulatory strategies in other cities to consider Toronto’s options. Finally, I demonstrate that the City’s powers will be insufficient at addressing the problems associated with payday loans. These finding indicate that municipal regulations on payday lending must work in conjunctions with regulations on other financial services to combat financial exclusion.
Why is there a demand for payday loans?
Servon (2017) identifies three main factors that have driven the growth of the payday lending industry: 1) a drastic contraction in consumer credit post-2008; 2) changes in the banking industry that restrict small-dollar credits; and 3) macroeconomic trends of declining wages, increasing income volatility, and growing job precarity. These economic conditions have financially excluded many lower income and racialized Americans from traditional credit services, thus providing an opportunity for payday lending businesses, which offer “quick fixes”, to grow (Servon, 2017).
The demand for payday lending is multifaceted and more complex than just poverty. However, it can ultimately be traced back to financial exclusion. Prager’s (2014) research on payday lenders across U.S. counties demonstrates that a key determinant of payday lending locations is the low measure of creditworthiness; in other words, establishments are usually located in areas where residents have a difficult time qualifying for traditional forms of credit due to poor credit histories. Additionally, American-based research correlating racial category and low-income to payday lending establishments are mostly mediated by under-banking (Cover, Spring & Kleit, 2011). Ultimately, the payday lending industry has emerged to serve those who have been failed by traditional financial services.
Although much of the payday lending research is based in the United States (U.S.), these observations are also applicable to the Canadian context. Although 97% of Canadians have bank accounts, 41% have been refused a credit card, 24% have been refused a checking account, and 18% have been refused a line of credit (Ipsos Reid, 2005). Furthermore, ACORN Canada’s (2004) reports that over 700 bank branches closed across the country between 2001 and 2003, mostly concentrated in lower-income neighbourhoods. At the same time, payday lenders have moved “aggressively into this competitive vacuum” (ACORN Canada, 2004). Overall, disenfranchised payday loan borrowers are “simultaneously targeted by payday lenders and neglected by traditional banks” (Graves, 2001).
As reported by the Canadian Centre for Policy Alternatives (CCPA), the majority of people borrow from alternative financial services as a last resort as they were denied credit services like credit cards, credit services, or overdraft protection from traditional banks (Fantauzzi, 2016). Although payday lending is the most popular service, most payday loan patrons borrow from other sources as well (Koku & Jagpal, 2015). Most borrowers also have low income as 70% of respondents earn less than $25,000 annually and over 70% of respondents borrowed from alternative financial services to spend on necessities such as abili, housing, bills, and alleviating poverty (CCPA, 2016). Evidently, the labour market is unable to support low-income workers in their everyday subsistence, and traditional banks are unwilling to provide the credit services that this groups of people need.
In addition to the aforementioned factors, many, including the government of Ontario, believe that borrowers are misled by the “$15 fee on $100 loan” marketing tactic that conceals the astronomical APR (ACORN Canada, 2004; The Province, 2018). However, Servon’s (2017) experience working as a payday lender, payday loan collector, and Predatory Loan Help Hotline counselor reveals that most borrowers are aware of the harms of payday loans. They continue to use these services because payday lending offers attractive features to fill the market gap. Loans can be made very quickly without traditional credit checks and the customer service is much more personable than that of banks. Moreover, borrowers do not have the cognitive resource to consider long-term consequences because the loans are so short (Spotton Visano, 2008; Servon, 2017; Koku & Jagpal, 2015). Overall, because traditional bank services are inaccessible and insufficient for the most socially marginalized, the payday lending industry has emerged to fill the demand gap.
Current regulatory strategies
In 2008, the Province introduced the Payday Loans Act, which gave the Province legal authority determined payday lending interest rates, issuing business licence, prohibiting certain lending practices, and provide protection for consumers (The City, 2018). Currently, the Province has established numerous regulations on payday lending businesses, including restricting borrowing rollovers and concurrent loans, prohibiting payday lenders to offer other services in relation to the payday loan agreement, and requiring payday lenders to give borrowers loan agreements upon entering the agreement (Deloitte, 2014; The Province, 2018).
These consumer protection measures are arguably non-negotiable in order to ensure that payday lending companies do not prey upon financially vulnerable customers. However, there are three main aspects of payday lending operations that can be adjusted through policy strategies to regulate payday loans: cap on fees, information disclosure, and the location and number of payday lending establishments.
1. PLACING A CAP ON LOAN FEES
A popular policy strategy to regulate payday lending is to impose a cap on loan interest fees. Ontario’s Payday Loan Act currently permits up to $15 interest for every $100 in loan, which amounts to an annual percentage rate (APR) of 390%. Different regions have experimented with different levels of interest as means to restrict payday lending establishments and protect borrowers from predatory charges. However, case studies from the U. S. demonstrate that loan fee caps do not necessarily benefit borrowers.
In 2010, Colorado legislation decreased the APR to 120% - which is a $120 interest on a $400 loan over three months – allowed loans to be repayable in small instalments, and lowered the APR if loans are paid back early (Horowitz, 2017). Within four years of regulation, more than half of the establishments closed, but remaining establishments doubled in customer count (Horowitz, 2017). In his analysis, Horowitz (2017) recognizes this outcome as a success, arguing that payday lenders can remain profitable and serve customers in need even with lower prices. However, Horowitz (2017) still identifies depository institutions like banks and credit unions as more capable of providing financial security for borrowers.
In 2007, Oregon legislation restricted the payment on loans to $10 per $100 for a maximum of 150% APR as part of a massive customer protection plan, and the number of registered licensed payday lending outlets dropped from 346 to 82 within one year (Zinman, 2010). Although this outcome can be perceived as a tremendous success, survey results indicate that more Oregon residents felt that it was more difficult to get a short-term loan, and that they have had to shift into “incomplete and plausibly inferior substitutes” (Zinman, 2010). Therefore, if the interest cap is not set at a manageable level, policies intended to protect customers can actually worsen their financial condition.
2. REGULATING INFORMATION DISCLOSURE
Another way that regulation can regulate payday lenders is by controlling how payday loans are advertised. In Ontario, numerous organizations have called for payday lenders to advertise loans based on the APR rather than fee per loan (ACORN, 2014; Deloitte, 2014). However, evidence for the effectiveness of such strategy is mixed. As Servon (2017) observes, payday loan borrowers are already aware of the risks associated with payday loans. This observation calls into question whether awareness and educational campaigns are actually useful initiatives.
Lawrence and Ellihausen (2008) use a cognitive psychology perspective to examine how borrowers approach payday loan payment information; they suggest that reasons like financial emergency, lack of self-control, and overestimation of one’s own ability to pay back loans all contribute to a cognitive limitation in processing the true risks of payday loans. To test this theory, Bertrand and Morse (2011) invited 100 stores of a large payday lending chain in the U.S. to offer customers four different level of information on payday loan fees. Results demonstrate that only the information type that encouraged borrowers to think more broadly about the cost of payday loans facilitated an 11% drop in future loan borrowing. This research Indicates that even if payday lending shops disclose the APR of payday loans, customers may be cognitively impaired to fully process the information in terms of cost and alternatives.
Moreover, even if information can be shaped to reduce payday lending, it cannot solve borrowers’ financial situation. From Bertrand and Morse’s (2011) study, it is unclear what happened to the 11% of borrowers who stopped borrowing. For one, they may be the subset of borrowers who do not depend on payday loans for survival. Alternatively, as there is little evidence that a reduction in payday loan borrowing leads to an increased use in traditional financial services, these borrowers may have turned to other high-cost financial services such as loan sharks and online loans instead (Edmiston, 2011).
3. RESTRICTING THE LOCATION AND NUMBER OF ESTABLISHMENTS
Finally, governments can introduce restrictions on the number of payday lending establishments and their location. The main argument this strategy is to prevent borrowers from seeking concurrent payday loans from different lenders, especially because Ontario does not permit payday lenders to issue concurrent loans and rollovers (Deloitte, 2014; The Province, 2018). In Ontario, Hamilton councillors have voted to limit payday lenders to one business per ward for a total of 15 establishments (Craggs, 2018). Additionally, Oshawa and Barrie both regulate payday lending through zoning bylaws (The City, 2018).
Location of payday lenders is often regulated through zoning bylaws, which can restrict establishments from operating near each other and other incompatible land uses (Martin & Mayer, 2017). For example, zoning bylaws can prohibit new payday lending businesses from operating within a certain distance from schools, banks, credit unions, or liquor stores in order to protect the original purpose of the area and vulnerable populations from predatory lending practices (Martin & Meyer, 2017). Alternatively, governments can enact policies to place a cap on the total number of payday lenders permitted within their jurisdiction (Foster, 2014). Some places like San Jose and Dallas both impose numerical caps on the number of payday lenders (Martin & Meyer, 2017).
As this is a relatively new policy approach, there is very little literature to examine the impact of locational restrictions on borrowers. However, similar to the other two strategies, location- and number-based regulations regards payday loan borrowing as a behavioural problem that can be stopped by limiting the availability of payday lenders rather than recognizing their financial disenfranchisement (Koku & Jagpal, 2015). Similarly, if we establish that payday lending is a product that fills a gap in financial services market, then heavy regulations are likely to be more harmful for borrowers if those financial gaps are not filled.
The City's new authorities are insufficient
Through a City of Toronto Act amendment, the Province has given the City the authority to issue municipal business licence for, restrict the number of, and regulate the location of payday lending establishments in the City (2018). This new authority will provide the city more leverage than zoning bylaws to target regulation on payday lending businesses to, for example, restrict the number of payday lending establishments in lower-income neighbourhoods and ensure that there are non-predatory financial institutions in the vicinity (The City, 2018; Foster, 2014). However, the City does cannot control interest rates or terms and conditions of payday lending.
Currently, Toronto City Council has incorporated interim regulations to cap the number of physical payday lending establishments to the current number of provincially-licenced businesses and to increase the cost of obtaining a payday loan licence (The City, 2018). However, the evidence from other regions suggests that this strategy would simply limit the supply of alternative financial services for the financially excluded without reducing the demand for payday loans in the first place. Therefore, Toronto’s new regulatory authority on payday loans are insufficient to resolve the root cause of payday lending: financial exclusion.
Recommendations and alternative options
In our increasingly financialized economy, the fundamental elements to sustain life, such as food, shelter, and health, have become contingent upon the availability of money and financial services (Gershman & Morduch, 2011). I argue that financial inclusion is an indispensable component to ensuring the integrity of section 7 of the Charter of Rights, which states that “everyone has the right to life, liberty and security of the person and the right not to be deprived thereof except in accordance with the principles of fundamental justice” (Constitution Act, 1982). As such, my recommended alternative strategies to the City’s current regulatory approaches are informed by Gershman and Morduch’s (2011) proposition that the right to access credit and financial services can be operationalized through legal non-discrimination. In other words, in addition to formulating payday loan regulations, the City and Province should also work to remove legal obstacles to providing access to financial services in order to ensure financial inclusion and foster “financial citizenship” (Koku & Jagpal, 2015; Gershman and Morduch, 2011).
1. WORKING WITH TRADITIONAL BANKS
I identify three key areas to where the City can enhance financial inclusion. First, although banks in Canada are regulated at the federal level, the City can develop policy guidelines and subsidies to encourage traditional banking institutions to set aside funding to offer small-credit services for the previously financially excluded. This strategy is informed by Koku and Jagpal (2015)’s corporate social responsibility (CSR) framework, which obliges corporations to voluntarily pursue social objectives in their operations. Through this framework, the authors also demand U.S. banks to reciprocate the public tax dollars that were used to bail them out during the 2008 financial crisis. Although Canadian banks have been considered to be relatively stable, CCPA economist David Macdonald suggests that various governmental agencies had provided $114 billion to support Canadian banks, which amounts to $3,400 for every person in Canada (CBC, 2012). Therefore, it is reasonable for the public to impose a social responsibility and duty on bank institutions to support and subsidize credit for communities in need of affordable credit services.
A Toronto-Dominion (TD) pilot project in British Columbia, Direct Deposit Initiative, has demonstrated that a CSR approach is viable and mutually beneficial for both the community and the branch itself. During this pilot, TD staff would set up kiosks at government offices to reach out to people who come in to the government building to receive their welfare cheques to set up direct deposit accounts (Trichur, 2010). The staff who developed the program, Jeff Gunn, observes that many potential clients do not have sufficient ID to get a bank account, which is a real legal barrier to participate in the economy (Trichur, 2010). To address this problem, Direct Deposit Initiative staff work with ministries to help clients order secondary IDs, set up direct deposit forms for social assistant payment and tax refunds to ensure that clients get immediate access to cash (Trichur, 2010). Since 2006, 2000 participants in the program have remained active accounts. Although this case study does not relate to the issuing of credit, it demonstrates the potential of traditional banks in developing innovative strategies to help underbanked citizens if given the social pressure and incentive.
2. SUPPORTING COMMUNITY ALTERNATIVE FINANCIAL SERVICES
The second strategy that the City can take is to offer institutional support for community-level alternative financial services. As Edmiston (2011) stresses, although there are many easily implementable alternatives to payday lending – such as cash advances on credit cards, payment plans with creditors, emergency assistance programs, and credit unions – they can only begin to combat the root of the problem if made accessible. According to Mohammed Yunus, a Nobel Peace prize laureate who pioneered microcredit programs in Bangladesh, credit services offered by community-based non-governmental organizations and socially-driven private financial institutions can be powerful because they can reach areas beyond a local government’s political authority (Gershman & Morduch, 2011). Therefore, the City should conduct further research into currently existing local organizations and alternative credit models and extend support if appropriate.
There are many alternative credit programs that have demonstrated innovative potential in helping financially excluded people in a socially responsible way. In Canada, microcredit has taken the form of community investment funds and denomination loans for low-income Canadians who are excluded from traditional financial services (Spotton Visano, 2008). By 2003, there had been more than 60 such funds in Canada. Using a peer-lending model where loans are made to a small group of people rather than individuals, microcredits mobilize “joint liability” contracts to reduce the barrier to obtaining loans and support among peers to ensure loan payback (Spotton Visano, 2008). Well managed programs have demonstrated a repayment rate of 95% in developing nations (Sadoulet, 2005). However, case studies from Canada and other developed nations indicate that the success of microcredit programs requires institutional support to promote social networks and offer training programs for business and computing skills (Spotton Visano, 2008). Coupled with the big bank CSR framework, the City can also encourage big banks to fund community-based microcredit programs as well.
Non-profit organizations and social enterprises can play a large role in implementing innovative alternative credit models. For example, the Mission Asset Fund (MAF, 2018) is a non-profit in San Francisco’s Mission District where 44% of households do not have credit scores and rely on payday lending services. The MAF (2018) started Lending Circle, a peer-based microcredit program that would provide credits at 0% interest and report client repayments to major credit bureaus to help people build the credit scores needed to participate in mainstream economy. Given the potential in community-based innovation, the City should actively research these alternative credit programs and offer support to foster financial inclusion in ways that extend beyond its legal authority.
3. WORKING WITH HIGHER LEVELS OF GOVERNMENT
In addition to regulating payday lenders at the municipal level, Foster (2014) suggests that local ordinance campaigns should also encourage higher-level governments to pass more meaningful legislations to address the root causes of payday loans. Ultimately, the City’s current authority is insufficient at solving financial exclusion as most of the regulatory powers for payday lenders and banks lie with Provincial and the Federal government.
One potential strategy to increase financial inclusion, the City should work with higher levels of government to mandate a credit-scoring system on repayments to payday loans (Edmiston, 2011; Servon, 2017; MAF, 2018). If borrowers resort to payday loans because they have a bad credit history and cannot obtain traditional forms of credit, then the logical approach would be to help them improve their credit. However, this strategy must work in conjunction with bank regulations as well. Given the drastic withdrawal of banks from lower-income neighbourhoods and reduction in small-credit services, there must be regulations in place to ensure that bank branches remain in these communities and provide competitive credit services (ACORN Canada, 2004). Ultimately, policies at different levels of government and community-level initiatives will need to work together to address the fundamental cause of payday loan: financial exclusion.
Conclusion
In this research, I have determined the emergence of payday lending to be a symptom of financial exclusion caused by an unprecedented withdrawal of banking establishments and economic precarity for lower-income families. Given that payday lending is simultaneously a predatory and necessary service for financially vulnerable borrowers, the City must carefully consider the extent and approach of regulation.
Ultimately, the City needs to understand the impact of payday loan regulation on customers. I conducted a literature review of existing payday loan regulatory strategies around North America and examined their effects on borrowers. Evidence from strategies such as interest cap, informational disclosure, and locational restriction suggests that Toronto’s new regulatory authority under the Payday Loan Act may be insufficient at resolving financial exclusion and actually worsen borrowers’ financial condition. Therefore, the City must support its current approach to payday lending regulations with other policy initiatives as well.
In formulating recommendations for the City, I am informed by the notion that financial inclusion should be non-discriminatory. Under this framework, the City should work to remove legal barriers to accessing non-predatory financial services in two main ways:
encouraging traditional banking institutions to provide small-credit services; and
support innovative alternative financial services operating at the community-level.
These municipal efforts should also work in conjunction with higher-level governmental regulations on the payday loan industry and banking institutions in order to address financial exclusion from all angles.
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