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Payday Loans versus Pawn Shops: The Effects of Loan Fee Limits on Household Use
Robert B. AveryFederal Reserve Board
Katherine A. SamolykConsumer Financial Protection Bureau Sept 23, 2011
The views expressed are those of the authors and do not necessarily represent those of the Board of Governors of the Federal Reserve System or the Consumer Financial Protection Bureau.
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2
This Paper
Uses data from the January 2009 Unbanked/Underbanked Supplement to the Current Population Survey
Examines how state-regulated fee ceilings on payday loans and pawn shops affect households’ use of these products
Explores conjectures about market dynamics (Flannery and Samolyk, 2007) Store operations involve largely fixed costs in supplying
the product Stores generally charge the fee ceiling rate If demand is relatively price inelastic (“good” a necessity,
few substitutes) Level of fee ceilings determines profitable scale of store
operations and number of stores needed to meet inelastic loan demand: Quantity of loans supplied need not change
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Findings Demand appears to be relatively price inelastic; funds
primarily used to meet basic living expenses and lost income
Payday loan use adjusted for demographic characteristics does not vary systemically with fee ceilings in the range where stores currently operate (except for the very lowest ceilings)
Pawn shop use is higher where fee ceilings are higher
Controlling for use associated with household demographics, stores per capita vary positively with fee ceilings
Within a range; lower ceilings may not markedly reduce payday loan availability
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Payday Loans
Fairly standardized: 2 week loans of several hundred dollars, typically 15-20$ fee per $100 borrowed
Minimal underwriting Borrower gives lender a post-dated check for amount
borrowed and fee ID, recent checking account statement, and a pay stub, check
of recent payment history (Teletrak) On maturity date, borrower pays loan or lender deposits check;
or borrower pays another fee and lender extends another loan to the borrower
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Pawn Shop Loans
Pawnshops loans are collateralized by the items being pawned; LTVs in the 40-60% range.
Borrower need not have a bank account, a regular source of income, or a credit check.
Trade groups estimate that the typical pawn loan is for about $80, with a contract maturity of 30 days and loan fee of 20 percent of the loan amount.
If borrower does not repay or renew; the lender takes physical possession of the item
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State Payday Regulations
States regulate payday lending Effective APRs generally exceed state usury ceilings
(>390% APRs) States generally have had to pass “enabling
legislation” permitting the payday product; regulations can include
Fee ceilings Loan amount limits Limits on rollovers or consecutive loans
Usury ceilings or very low payday loan fee limits effectively “prohibit” payday lending in 13 states and DC
7
State Pawn Shop Regulations
Pawn shops also regulated by states; regulations can include: Fee limits The amount of time before a loan is considered in
default Return requirements (that sale proceeds in
excess of the loan amount and fees must be returned to the borrower)
Pawn shops operate in all states; even those with very low limits
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Evidence about Customer Use Evidence of frequent payday loan use: Caskey (2005): state government data show most customer use payday
loans more than 6 times a year; one quarter had 14 or more loans during the year.
Flannery and Samolyk (2007): store data from two large payday lenders: 40 percent of loans were roll-overs/renewals; roughly one half of loans were to accounts that had taken out more than six loans that year
Skiba and Tobacman (2008) data for a large payday lender indicate half of the borrowers default on a loan within a year of their first loan; but have paid fees for five payday loans before they defaulted (90% of original loan’s principal).
Evidence that payday borrowers are likely to be financially constrained (although working, moderate income and educational attainment) Ellihasuen and Laurence (2001) credit card balances near limits;
outstanding balances Logan and Weller (2009) lower wealth, more likely to have been
denied credit
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Evidence about Customer Use
Less known about pawn shop use: According to Pawnshopstoday.com, “Around 80 percent
of pawn loans tend to be repaid and that repeat customers account for much of the loan volume; often borrowing against the same item repeatedly.”
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Evidence About Supply Side Focal Point Pricing (DeYoung and Phillips):
Charge payday ceiling rate and compete away excess profits by entry
Flannery and Samolyk (2007)
Stores tended to charge ceiling rates
Scale economies imply that profits related to loan volume: more loans, bigger loans
Prager (2009) Higher fee limits associated with more payday stores
per capita
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Evidence About Supply Side
Higher fee limits associated with more payday stores per capita (Caskey(1991), Prager (2009), Shackmen and Tenney (2006))
Some evidence that pawn shops make larger loans when ceilings are lower (Shackmen and Tenney, 2006)
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How do fee ceilings effect availability of payday and pawn shop loans?
Within current range of ceilings where lenders can operate
Conjecture one Higher fee ceilings should reduce demand But if there is excess demand at the ceiling rate; supply
determines equilibrium quantity Higher fee ceilings increase the quantity sold
Conjecture two Higher fee ceilings reduce volume of loans needed to cover fix
costs and be profitable Increases the number of stores a market can support Relatively little affect on quantity sold
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Our Strategy
The 2009 Unbanked/Underbanked Survey: A supplement to the Jan 2009 CPS sponsored by the FDIC. Large nationally representative sample allows state-level estimates of usage.
Included questions about :
Use of payday loans and pawnshop loans
Reasons for using a product rather than going to a bank
Reasons why the credit was needed
Matched with the rich CPS demographic data
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Our Strategy
We use CPS data to estimate loan demand associated with household demographic characteristics using only within-market variation.
Use these estimates to construct geographic estimates of usage adjusted for the demographic component of demand.
Examine how adjusted-usage estimates are related to state fee ceilings
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Payday Loan and Pawnshop Demographic Demand
60 percent of borrower say they could not borrow elsewhere.
Major use of funds: basic living expenses; lost income and specific bill or expense also important reasons
Multivariate results: Demographics of Use Higher payday or pawnshop use: renter; has children Unemployed;
moderate age (25-45); divorced, separated or widowed; Lower use of both product: college degree; foreign born Higher payday use: disabled; moderate income; moderate education;
single female head of household; Black; Native American; (Lower use among retired)
Higher pawnshop use: unbanked; lower income; single; smaller renter effect; larger Native American effect; smaller Black effect; larger UE effect; less of an education effect; no FHOH effect;
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Table 5: Multivariate Analysis of Household Demographics and AFS Credit UseA: Use payday loan 1 B: Used Pawnshop 2
Independent Variable Coefficient Std. Error Coefficient Std. Error
Unbanked -0.0051 0.0049 0.0469 0.0034 <.0001***
Renter 0.0486 0.0030 <.0001*** 0.0091 0.0021 <.0001***
Race (NHW)
Black 0.0586 0.0040 <.0001*** 0.0084 0.0028 ***
Native American 0.0253 0.0104 * 0.0262 0.0073 ***
Parentage (no chlidren)
Children 18+ 0.0204 0.0052 <.0001*** 0.0173 0.0036 <.0001***
Children <18 0.0320 0.0055 <.0001*** 0.0174 0.0039 <.0001***
Labor Force Status (employed)
Unemployed 0.0192 0.0050 *** 0.0434 0.0035 <.0001***
Retired -0.0105 0.0045 * -0.0041 0.0031
Disabled 0.0140 0.0055 * -0.0013 0.0039
Household Income (LT$15K)
HH income$15-30K 0.0102 0.0044 * -0.0122 0.0031 <.0001***
HH income 30-50 0.0138 0.0045 ** -0.0175 0.0031 <.0001***
HH income $50-75K 0.0027 0.0049 -0.0263 0.0034 <.0001***
HH income>$75K -0.0075 0.0050 -0.0289 0.0035 <.0001***
Householder Age (LT 25)
Age 25-34 0.0260 0.0056 <.0001*** 0.0107 0.0040 **
Age 35-44 0.0227 0.0058 <.0001*** 0.0113 0.0041 **
Marital Status (married)
Widowed 0.0132 0.0063 * 0.0097 0.0044 *
Divorced/separated 0.0199 0.0053 *** 0.0165 0.0037 <.0001***
Single 0.0039 0.0054 0.0085 0.0038 *
Education (no HS diploma)
High school diploma 0.0070 0.0040 -0.0014 0.0028
Some college/AA 0.0151 0.0042 *** -0.0022 0.0029
College degree -0.0117 0.0049 * -0.0109 0.0035 **
Post graduate -0.0116 0.0049 * -0.0051 0.0034
Female head of household 0.0213 0.0057 *** -0.0044 0.0040
Foreign-born -0.0273 0.0043 <.0001*** -0.0161 0.0030 <.0001***
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How Fee Limits Affect Use
State Fee Limits per $100
State Group Payday Fee
Range Pawn Fee RangeNot Permitted NA
Low $10-$12 $1-$9
Medium $15-$16 $10-$19
High $17-$20 $20-$25
No Ceiling/Very High > $20 or None None
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Second Stage: Fee Ceilings and Loan Use Net of Demographics
Dependent variables: Usage adjusted for demographics (actual usage less usage predicted by demographics) in a given geographic area (Equivalent to “fixed effects” from 1st stage)
Sample includes 365 geographic areas identified in the CPS data in states where payday stores can operate
Explanatory variables include: Fee ceiling categoriesCategorical variables for broad region; rural
dummy; median income of market where the area is located
Relative fee ceilings on “substitute” product
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Nonlinear effect of payday fee ceilings on usage adjusted for local demographics; lower in the lowest payday fee-ceiling group—but also lower in the high fee-ceiling group ($17-20 per $100)
Pawn shop use is highest in the high fee-ceiling group ($20-25 per $80)
Table 6: Multivariate Analysis of Fee Ceilings and Adjusted AFS Credit Usage
A: Incidence of Payday borrowing adjusted 1 B: Incidence of Pawnshop borrowing adjusted 1
Coefficient Std. Error Coefficient Std. Error Coefficient Std. Error CoefficientStd. ErrorIntercept 0.0050 0.0067 0.0042 0.0069 -0.0171 0.0128 -0.0061 0.0042
Payday fee ceiling group 3
Group 1 (lowest ceilings) -0.0271 0.0060 *** -0.0286 0.0066 ***
Group 3 -0.0103 0.0046 * -0.0094 0.0047 *
Group 4 0.0054 0.0084 0.0051 0.0084 Group 5 (no ceilings) -0.0063 0.0071 -0.0065 0.0071
Pawn shop see ceiling group 4
Group 2 (next to lowest ceilings) -0.0092 0.0050 -0.0034 0.0039
Group 3 0.0238 0.0127 0.0129 0.0032 ***
Group 4 (no ceilings) 0.0137 0.0138 0.0048 0.0042Relative pawn shop fee ceiling Lower -0.0041 0.0043 0.0222 0.0121 0.0074 0.0043 Higher -0.0073 0.0083 0.0018 0.0067 -0.0006 0.0032
Region: North -0.0013 0.0055 0.0002 0.0058 -0.0129 0.0041 ** -0.0099 0.0035 **
Region: West 0.0112 0.0047 * 0.0135 0.0052 0.0069 0.0028 * 0.0068 0.0025 **
Rural -0.0010 0.0055 -0.0001 0.0057 -0.0047 0.0035 -0.0063 0.0030 *
Market income group 2 0.0003 0.0061 0.0016 0.0063 -0.0005 0.0038 -0.0008 0.0033Market income group 3 -0.0003 0.0068 0.0015 0.0070 -0.0027 0.0044 -0.0031 0.0037Market income group 4 (highest) -0.0125 0.0076 -0.0106 0.0078 -0.0030 0.0050 -0.0047 0.0040
Dependent Variable Mean 0 0 0 0Number of geographic areas 2 365 365 365 516r squared 0.0765 0.0799 0.1416 0.1310
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Effects of Fee Ceiling on Specific Demographic Groups
Table 9: Pawnshop Residuals by State Fee Ceilings<$10 $10-$19 $20-$25 No Ceiling
Variables Group Group Group Group
Total Households -0.012 -0.001 0.004 -0.003Race
Black -0.025 0.003 0.002 -0.014
Hispanic -0.008 -0.005 0.010 -0.010
Asian -0.003 0.003 0.000 -0.002
Native American -0.048 -0.001 0.020 -0.017
Other race -0.011 0.005 -0.008 -0.024
NonHispanic White -0.010 -0.002 0.003 -0.001
Household Income
HH income<$15K -0.033 0.003 0.009 -0.015
HH income$15-30K -0.015 -0.002 0.003 0.005
HH income 30-50 -0.014 -0.005 0.008 -0.003
HH income $50-75K -0.005 -0.001 0.005 -0.005
HH income>$75K -0.004 0.000 0.001 -0.003
HH income missing -0.009 -0.005 -0.002 0.000
Education
No high school diploma -0.021 0.002 0.005 -0.005
High school diploma -0.016 -0.002 0.004 -0.003
Some college/AA -0.012 -0.004 0.005 -0.003
College degree -0.005 -0.002 0.005 -0.001
Post graduate -0.004 0.002 -0.003 -0.005
Female head of household -0.029 0.004 0.001 -0.016
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Fee Ceilings and Stores per Capita
Only have store count data at the state level
Use estimates from demographic regressions to summarize mean use (demand) at the state level
Find state fee ceilings (and demographics) are strong predictors of the number of payday stores and pawn shops per capita.
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State fee ceilings (and demographics) are strong predictors of the number of payday and pawn stores.
Table 7: Multivariate Analysis of AFS Credit Fee Ceilings and Stores per Capita
Panel A: Number of payday stores per-capita
Coefficient Std. Error
Intercept -2.4352 0.6319 ***
Payday fee ceiling group 2
Group 1 (lowest ceilings) -0.4631 0.2071 *
Group 3 0.3321 0.1527 *
Group 4 0.9400 0.3251 **
Group 5 (no ceilings) 0.5290 0.2779
Estimated demand from Demographics 74.0100 14.1603 ***
Dependent Variable Mean 1.0331n 37.0000r squared 0.6599
Panel B: Number of pawnshop stores per-capita Payday States All States
Coefficient Std. Error Coefficient Std. Error
Intercept -0.7320 0.2794 * -0.7754 0.1957 ***
Pawn shop see ceiling group 3
Group 2 (next to lowest ceilings) 0.2674 0.1202 * 0.2438 0.0822 **
Group 3 0.4473 0.1069 *** 0.4238 0.0769 ***
Group 4 (no ceilings) 0.3429 0.1458 * 0.3425 0.0957 ***
Estimated demand from Demographics 40.2732 11.6707 ** 43.1111 9.0218 ***
Dependent Variable Mean 0.4373 0.3993
n (states) 1 37 51
r squared 0.5516 0.6450
*, *, *** : Significant at the 5%, 1%, and .1% levels
1 First column regressions only use geographic areas in states where payday lending is permitted.
The second uses all areas.
2 Base group is states with $15-$16 fee caps3 Base group is states with the lowest fee caps
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Payday Loans and Pawn shop “Substitutability”
Table 10: Interactions between Payday and Pawn Shop Fee CeilingsAverage Incidence of product usage by group adjusted for demographicsPayday loansPayday loan Fee Ceiling
Pawn Shop Loan Fee Ceiling
Lower Same HigherNo Payday 1.20 1.14$10-$12 1.62 3.37 2.40$15-$16 5.22 4.59$17-$20 4.31 4.66 4.39High or No ceiling 4.15 5.90Pawnshop UsePayday loan Fee Ceiling
Pawn Shop Loan Fee Ceiling
Lower Same HigherNo Payday 1.11 1.92$10-$12 0.85 3.65 2.18$15-$16 1.65 1.89$17-$20 1.97 2.48 2.39High or No ceiling 1.86 1.77
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Findings
Demographics do explain a lot of the cross-market variation in usage.
Adjusted Payday Use appears to be relatively uncorrelated with state fee ceilings Lower in the lowest fee ceiling group but also in the
medium fee ceiling group ($17-20 per $100 borrowed); even though lower ceilings appear to reduce the number of stores
Adjusted pawnshop is somewhat more sensitive to fee ceilings; highest use in higher fee group ($20-25 per $100 borrowed) and stores per capita are the highest for states in this fee group
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Issues
Use of small high cost loans: repeated use to make ends meet
Other AFS products: Auto-title lending; refund Anticipation loans; RTO
Direct deposit advance
What is the best we can do? Product limitations Disclosure, framing the costs Enforcement Subsidize more affordable product