Payday Loans — Time for a Re-Examination
Written by Cameron MacKay, Alberta Counsel
Payday loans (also known as short-term loans) have garnered the ire of politicians for the past decade. The complaints have generally centered around interest rates, collection practices, or the fact that banks will not offer loans to people with a credit score below a certain threshold. Across Canada, various jurisdictions have begun to “re-regulate” the industry by unleashing a series of new legislation aimed at restricting how, where, and when the service of short-term lending can occur.
In Alberta, we now have some of the strictest legislation surrounding short-term loans. Many of these regulations have been based on the incorrect premise that short-term lending is a very profitable industry. However, the facts do not fit the narrative. A 2007 report by the Fordham Journal of Corporate and Financial Law points out that the short-term lending industry was earning a modest 3.57% profit margin. When you consider the fact that the risk of loan default in this sector is between 15-20% higher (compared to 1% for a credit card company), it becomes apparent that the profit margins are quite thin. With Alberta’s tough regulations, the profit margins are even smaller while the amount of loan approvals has dropped from over 90% to under 40%. What this means for the average Albertan is that in the not-so-distant future, this industry will not exist unless regulations are amended. When that day comes, government will have to ask itself how this service can be delivered through the public sector, or, should we change the regulations today to continue servicing this need through the private sector?
Most of us will not make use of a short-term loan. We will have sufficient savings and employment income to buttress ourselves through the tough times. When life throws those unexpected expenses at us, we are able to balance our finances without much difficulty. When you get a flat tire on your car or your electricity bill is more than expected, you are able to pay these bills through existing credit, liquid cash or savings.
This begs the question: who uses a short-term loan? The answer is ALICE (Asset Limited Income Constrained and Employed).
ALICE will earn around $50,000 per year, are employed, may or may not have a family, and for all intents and purposes, are your prototypical Albertan. Unlike you, if ALICE had an unexpected $200 increase in their water bill or had a $500 car repair to pay for, they could not handle these expenses without help because their income does not match their expenses.
This is the reality for many Albertans and what they do is they rely on short-term loans to help pay the water bill. The reason they do this is because it makes financial sense. Paying $40 for a short-term loan is much better than having to pay the reconnection fees for your water bill or missing work because your car is broken. For many Albertans, short-term loans are a way to manage their finances in a sensible manner when cash flows are misaligned with expenses. Without this essential service, where do Albertans in need turn?
All of this points to a need to re-examine the role of short-term loans and how they serve the community. Are they something that should be offered by the government, or would the cost and business risk be something best absorbed by the private sector? Alternatively, is this a sector that could be reformed?
The one regulation that needs to be changed to keep the short-term lending industry alive in Alberta is section 124.3 of the Consumer Protection Act. This section requires an installment loan to be between 42 and 62 days, thereby eliminating the short-term loan whereby you borrow $200 and pay back $40 next week. In turn, why not take a different approach to short-term loans? Why not allow them to help consumers build credit and increase financial literacy? Requirements for credit reporting by short-term lenders would enable average Albertans to help themselves by enabling them to build credit and graduate to a different credit product.
Instead of being punitive in our regulatory approach, why not recognize that short-term loans are a required product servicing a group of Albertans that are not currently served by regular banks? Perhaps it is time to re-examine short term lending in Alberta.