Three bills in the House and one in the Senate that were submitted this spring seek to curb one of the industry's most controversial practices: charging triple-digit interest rates for short-term loans to risky customers. The bills would impose caps as low as $15 for every $100 borrowed and, in some cases, require greater transparency of the lending terms.
But industry representatives say they provide necessary services for households that have become alienated from traditional financial institutions. Many of their customers have poor credit and may not qualify for basic bank accounts. The payday-lending industry has opposed capping interest rates, and its trade group, the Community Financial Services Association, is raising $1 million from its members to lobby against the bills. CFSA spokesman Steven Schlein said the group has reserved judgment on the proposed Consumer Financial Protection Agency.
"It's all in the details," he said. "It would be a big change for us."
The Financial Service Centers of America, which represents check cashers, said that it supports increasing transparency to customers but that additional federal regulation "is unnecessary and duplicative and will only increase the cost of financial services to consumers without any corresponding benefit." The trade group for payday lenders said it began requiring members to display their fees on posters in their stores last year.
The industry, eager to protect its profits, is pushing innovation. They should be reminded that innovation also played a big role in the subprime crisis. However, the fact is that if it isn't viable for whatever reason to offer services to the poor, then the industry won't be able to offer them no matter what legislation says, unless there are subsidies.
Industry advocates argue that innovation -- not legislation -- is the key to reform. And the private sector has been quick to step in with other solutions.
Some credit unions offer short-term loans as an alternative to payday lenders. North Side Community Federal Credit Union in Chicago, manager Ed Jacob said, introduced a six-month, $500 loan with 16.5 percent interest several years ago. The credit union has since made 5,000 such loans, and it has become one of the most popular products.
Meanwhile, start-ups such as Progreso Financiero in California are targeting new niches. James Gutierrez founded Progreso in 2005 to make short-term unsecured loans of $250 to $2,500 to Hispanic families lacking credit scores and banking records. The company charges 36 percent interest, significantly less than other payday lenders charge but still more than double the average consumer credit card interest rate.
Financiero has made about 25,000 loans to its customers in California but needs to make 100,000 before it can turn a profit because the loan amounts are so small and the cost of doing business is high, Gutierrez said. Jacob said the credit union doesn't make any profit from its payday-loan alternatives. Instead, it hopes to boost members into good financial standing so they can then apply for profitable products such as auto loans.
Some industry veterans are also moving into the sector. Just this year, Wal-Mart lowered the price of its prepaid debit card to $3 and its fee to cash checks to a maximum of $3. It also allows shoppers to pay many of their bills in stores. The giant retailer estimates that about 20 percent of its customers are unbanked.
"Our customers are living paycheck to paycheck and watching every penny," said Jane Thompson, director of Wal-Mart's financial services.
North Side Community Credit Union and Financiero are the types of innovation we need to see. As I stated in an earlier post, the poor deserve to have access to free, basic financial products - a checking account, a debit card, and perhaps a credit card with a low limit. There must be no weasely fees, and the checking account must be free. The only way for banks or credit unions to offer those services to the poor is to cross-subsidize using more profitable auto or housing loans.
There is an additional problem with financial literacy.
But perhaps the biggest hurdle the industry faces is improving customers' financial literacy. Many are afraid of leaving their money in banks, do not have the documentation to open a bank account or have had accounts closed. They also may not understand how loans are structured.
D.C. resident Gregory Warf, 20, said he doesn't want a bank account. He turns his savings over to people he trusts, like his brother, or hides it. If he needs to cash a check, he goes to the nearest liquor store, which charges him a fee. And if he needs money -- say, $10 to put on his SmarTrip card -- he asks a friend.
"I'd rather have my money in my possession," Warf said. "I don't really trust anybody else."
I'm fairly sure, though, that the first step is getting credit unions and possibly banks to offer acceptable products to the poor - acceptable products that don't have weasely fees and terms.