Originally published at https://www.americanbanker.com on March 27, 2023.
Last year, my state of New Mexico passed ostensibly progressive legislation capping interest rates at an annual percentage rate (APR) of 36 percent. The move was intended to shut down predatory payday lenders, and supporters of the legislation assured those who believed the legislation would leave a void in the market for specialized emergency loans that in fact, that void would be filled by banks who would step in to offer this kind of credit.
Recently, news broke to suggest this was happening: Banks claimed that they would in fact be providing small dollar, short-term loans to customers left without credit options in the aftermath of the ban — and others like it in states like Illinois — taking effect. However, as part of an investigation conducted by my organization, the Southwest Public Policy Institute, it has become clear that this narrative is what you might call “fake news.” Once again, big banks — powerful actors within our financial system — sold the guardians of good governance and the media a lie, and unfortunately, the lie was treated as fact.
I recently spent over eight hours — and $75 in cash — attempting to borrow a few hundred dollars from three national banks with branches in the Land of Enchantment. All three times, I was rejected. As for other banks purporting to offer this type of credit, I was not even able to apply — because they do not operate or offer the services in question in New Mexico at all.
So much for claims from Pew Charitable Trusts that big banks offer “safer and more affordable” borrowing “for customers who previously would turn to high-cost payday loans or other alternative financial services.” It appears that they, and media figures like the Santa Fe New Mexican’s Milan Simonich, who declared that “banks are providing small loans to New Mexico customers at reasonable rates, all at a rapid clip,” have been duped.
To test the state’s small-loan offerings, I visited Bank of America, Wells Fargo, and U.S. Bank branches in the Albuquerque metro area and filled out applications for specialized emergency loans — to no avail. Despite the fact that I am a married, middle-class father of three with excellent credit (over 750 credit score), a mortgage in good standing, and no criminal record, all three banks required me to have maintained a personal checking account, with recurring direct deposits having been made into the account in question, for at least six months. Needless to say, such requirements mean any credit offered by the banks in question could not possibly serve the needs of someone in an emergency — something that the products “replaced” by these supposed loans frequently did. The process of applying for the loans, which, again, I did not get, was also hardly quick, cheap or easy — attributes you would hope would apply to “emergency lines of credit.” Again, my total expenses were $75, and I lost a full workday’s worth of time.
My conclusion: What is actually going on here is banks may be using the de facto banning of short term, small dollar loans to entice customers into opening accounts with them in the hope that somewhere down the line — in, say, six to twelve months from an account’s opening — they may able to access a bank loan. But those loans are not actually being offered as it stands to consumers looking for a replacement to now-banned payday or installment loans. And of course, they may never be because unlike me, many of these borrowers do not have an excellent credit rating and represent lending risks to the banks, even though they may represent a profit line for the banks insofar as they can be enticed to open checking accounts, potentially complete with overdraft fees if they want to overdraw their accounts as a form of high-cost, short-term, emergency credit. A cynic might say that result will inevitably obtain.
Anti-predatory lending crusaders may want to believe that their lobbying has helped New Mexicans in need of emergency loans for expenses such as car repairs and unexpected travel. But my experiences show that unless the banks purporting to offer this type of credit dramatically shift their offerings and terms, this is nothing more than a pleasant fiction.
In contrast to the banks purporting to offer this type of credit [the three with branches in the Albuquerque area I visited and others who do not lend in New Mexico], specialized emergency lenders provide fast cash to borrowers even with poor credit scores to cover emergency situations or help pay a borrower’s expenses from one paycheck to the next. The industry’s enemies charge that the APR for its loans is outrageously high (of course, APRs vary from lender to lender and customer to customer). But the accusation is deeply dishonest, misleading, and potentially even irrelevant. Using APR — a 365-day assessment — to assess the cost of a loan that lasts, on average, 111 days or less than a third of the 365-day period is nonsensical. As economist Thomas Sowell observed: “Using this kind of reasoning — or lack of reasoning — you could quote the price of salmon as $15,000 a ton or say a hotel room rents for $36,000 a year, when no consumer buys a ton of salmon and few people stay in a hotel room all year. It is clever propaganda.”
Research has shown that crackdowns on small-dollar, short-term lending push many borrowers to seek out alternatives such as pawnbrokers, loan sharks, and direct-deposit advances. Where banks have been demonstrated to step in and provide replacement credit, it’s not in the form of sub-36 percent APR bank loans; it is in the form of overdrafts with APRs that make the most eye-watering of payday loans look dirt cheap. Notably, the New Mexico APR cap legislation excluded overdraft fees, and banks and credit unions supported that. They also financially backed organizations that lobbied for the legislation itself. Inevitably, given racial and ethnic disparities in income and wealth — and New Mexico isn’t exactly the whitest, richest state in the nation — curtailing access to credit or forcing people into higher APR products like overdrafts will have a disproportionate — and disproportionately bad — impact on low-income and minority communities.
Feel-good public policy often has the opposite effect of what its advocates seek. In New Mexico, the 36 percent APR limit imposed in 2022 is still in its early stages, but the Law of Unintended Consequences seems to be at work already. The campaign against specialized emergency loans is turning out to be a failure for the state’s unbanked and underbanked population– and even perfectly-well banked, better-off people with great credit scores like me. As a result, there may be more government interventions proposed to “fix” the issues that were caused by well-meaning but fundamentally uninformed activists and politicians.
Instead of virtue-signaling regulations, policymakers should consider implementing “rules of the road” that promote greater competition in financial services. Clearly defined and consistently enforced standards can guarantee that the lending market is accessible to all providers and also protect consumers. To truly assist middle- and low-income families, the focus should be on expanding options rather than restricting nontraditional credit options. A healthy marketplace should not be replaced by ideology and optics.
Originally published at https://www.americanbanker.com on March 27, 2023.