In my experience as a financial technology investor focused on the needs of the emerging middle class, I have found that attitudes around payday lending generally diverge into two main camps.
Either it is an evil inflicted on the less financially fortunate amongst us, or it is a highly demanded alternative to bank overdraft and other choices. Whatever your own stance, everyone should agree that payday loans are an expensive product and wish it were better.
Our investment philosophy holds that social impact can be an economic multiplier: addressing society's biggest issues through the private sector can create better than market returns. Sustainable, scalable business approaches are critical to lasting social change. We can and must eliminate the binary thinking on payday lending using this same approach. So at the risk of sounding simplistic, here is my five-step recommendation for transforming payday from a great divider into a great unifier.
Payday is an inefficient industry. Fixed overhead costs are high and losses are astronomical compared to just about any other form of credit on the market. Ironically, online payday is even less efficient and therefore even more expensive than its brick-and-mortar variation. Why? In my experience with companies, this can cost more than $100 a lead. So-called "lead generation" companies which sell customer leads to lenders for a fee bid up and buy up payday related key words on Google. On last count, over half of Google ads for "payday" were not fully regulated lenders, but instead a mix of companies that generate leads and offshore or tribal lenders.
Google should emulate its pharmaceutical model in order to "do no harm" in the payday industry. Create a third-party vetting agent that will limit ad-word buys for payday lending to fully regulated lenders. By helping reserve ad-words to these entities, Google can help gradually improve quality and decrease the overall cost of a payday loan.
Some lenders partner with Native American tribes to skirt state lending laws. This loose federation of rules has no conformity and makes a national lending program impossible. Instead of pursuing one-off payday lenders a policy that will prove endless and eventually swallow its own tail federal regulators need to build a strong and unified foundation upon which we can design a national lending program. A national short-term lending charter that is stronger than state laws is good for everyone: lenders, regulators and, most of all, borrowers. With this charter in hand, the Consumer Financial Protection Bureau can then effectively set and track rates, policies and punishments that conform to responsible lending practices and best practices.
Build with a Blueprint
. Once we have the baseline established in the form of a CFPB national charter, then we must help lenders innovate and expand on top of it, according to a set of guidelines. Almost every industry has a code of ethics think of the Hippocratic Oath in medicine. If we can agree on a framework of higher standards, then the industry can begin to police itself and focus on how to profitably serve its customers.
I am a big fan of the Center for Financial Services Innovation's Compass Principles
. I have something of a rooting interest because of the close relationship and synergy in missions between CFSI and my firm. However, the Compass Principles provide a workable, realistic and readily achievable set of rules against which this industry can operate. Payday lenders will find that the Compass Principles acknowledge the need for shareholder profitability and scale within the business as better outcomes for borrowers. By agreeing to these principles, lenders demonstrate a commitment to the consumer and can differentiate themselves as responsible entities. All lenders should play by these principles and work with CFSI to make them better.
Advocates need to take a page out of the anti-tobacco playbook. Payday defenders have used the "you can't regulate demand" argument to successfully and repeatedly block fatal legislation. This is the same argument that gave the tobacco lobby such long life. But in the end, anti-tobacco advocates won the battle by showing the impact of secondhand smoke. In this way, smoking became a public health issue that affected people beyond smokers. This is what eventually led to strict tobacco legislation.
Advocates must do the same for payday lending. Show the wider impact of the payday industry beyond just the person securing a loan at a single point in time. It should be relatively simple to study the effects of payday lending on extended communities of borrowers and any impact it has on income, property value, crime, etc. Focusing on the borrower is a losing battle. Demonstrating a broader impact can build a movement that will force better regulations and clean up the overall industry.
It's too easy to justify payday simply because there is demand. That would suggest many greater vices should be freely available. Arguably, the greatest perpetrators of payday are instant gratification and poor planning, not "predatory" lenders. A recent New York Times story
made the case that we need to make broccoli cool, not decry fat, corn and salt. Similarly, we need to make saving cool again. The Recession has forced many families to do just this, but the availability of this type of short-term credit, where other credit remains scarce, questions whether we have learned from our mistakes.
Public, philanthropic and corporate partnership should give saving and fiscal discipline a catchy jingle and social cachet. This is as important and doable as making broccoli cool.
Arjan Schutte is founder and managing partner at Core Innovation Capital.