Introduction
Over the past three decades, Australia has been undergoing a process of economic liberalization. In this process, economic growth has been identified as the most crucial path towards the elimination of poverty and inequality (Dollar and Kraay, 2002). Consumption has continued to stimulate employment, which is largely driven by the private sector. There is also the contribution of the belief that market forces will continually self-correct any supply and demand imbalances (Whitwell 1998). Loundes (1999) observes that Australians save less and are often willing to accept a high level of household debt as a norm while at the same time demanding more credit. However, at the same time, there has been a decline in real wages on the one hand and an increase in the number of Australians who live in poverty (Davidson, 2008).
Low-income consumers tend to end up being more vulnerable to sudden, unexpected financial shocks, a situation that forces them into seeking payday loans (Wilson, 2002). Currently, the Australian government is deliberating on some regulations that are set to take the form of terms and conditions for issuance of payday loans. These terms include a fee capping that is considered by many in the sector as a short-cut towards the elimination of the entire industry.
A payday loan is simply a small cash advance designed for repayment within a month. It differs from a typical bank loan in that its value is usually small, usually not extending $1000. Moreover, it can be repaid within days unlike the typical bank loan, which may take years to pay. In a payday loan, charges are expressed as flat fees and not as interest. This loan is unsecured and it is paid through direct debit of the bank account of the customer on the agreed date.
According to Hughes (2009), the industry has continued to grow at an impressive rate, especially if one compares the $200 million lent in 2002 to the more than $800 million lent in 2009. According to Hughes, this is an indication of the triumph of a liberated economy’s entrepreneurial spirit. However, the fees that bank levy on payday loans are higher in comparison to those of a typical bank loan. For instance, if one borrows $500 to repair his car and repays a total of $675, the resulting charge of 35% appears very expensive. Such high charges have made consumer interest groups, policy makers, and industry representatives become embroiled in a fierce debate on ways of regulating this credit facility. The concerns are centered on the fact that these loans, which are legally made available to low-income consumers, are perceived to impact negatively on the beneficiary’s quality of life and prosperity. This clear, fundamental argument may be very hard to dispute. It beats logic to expect customers who are struggling to make ends meets to become better off by paying off loan charges that are viewed as expensive. Protection groups consider this a form of exploitation of the low-income group in the latter’s desire for credit, whereby the expensive loans only plunge them deeper into financial problems (Drummond, 2011).
The nature of literature on payday loans
Literature on the payday loans industry has three main characteristics. To begin with, it is highly polarized, subjective, and highly biased. It is sponsored by either consumer or industry advocates. As noted by Neil Ashton in Payday Lending Literature, there is for all stakeholders to go beyond the task of evaluating conflicting statements by establishing whether each argument is genuine or it is simply a case of ‘the money-speak’. Secondly, it is methodologically flawed. Even reputable reports produced by professional research firms fail to offer information on sources of data, the person who collected them, and the timing of their reports regarding capping of interest rates. Thirdly, literature on payday lending tends to address similar questions while repeating the same old answers to these questions. The questions often dwell on whether payday lending is an astute business or it is just an avenue of exploiting vulnerable consumers. Questions on who are the typical borrowers and whether there are better ways of getting payday loans are also frequently fronted, yet they trigger the same old answers.
This academic study asks the vulnerable consumers of this industry to offer insight on how they funds fit into their overall lifestyles. It also seeks to have them explain objectively or subjectively whether they are better off or worse off spending these loans. This study will also offer details on how this industry operates without any interest of influencing the perception against or for it. The researcher believes that payday lending remains one of the issues that an individual ought to work hard for a very long time so as to be wise and avoid loud opinions.
Much of the literature analyzed here is from the US, where the payday lending industry remains larger than in Australia. In each state, the legislative approach differs with regard to payday lending. There is also a major different in the method used to pay off the loan. Whereas in the US this takes the form of a post-dated check, in Australia, repayment is done through a direct debt agreement. It may be rather confusing to compare the payday lending terms used in these two countries.
           Definitions
Many terms are often used to define payday loans. Some of these terms include ‘short-term loan’, and ‘cash advance’. In the industry, it is referred to as ‘micro-lending’ or ‘fringe credit’ (Wilson, 2002). Sometimes, a difference is made between fringe credit and mainstream credit, though this distinction is not always clear. According to the Ministerial Council on Consumer Affairs (2007), for instance, the mainstream market is made up of banks, building societies, credit unions, national finance companies, and non-bank mortgage lenders. On the other hand, fringe credit providers provide short-term loans to people who cannot access loans from mainstream lenders. Some industry players interchange the use of the terms ‘payday loans’ and ‘micro-loans’.
 History of payday lending
The payday lending industry can be traced to the check cashing industry. According to Ashton (2008), other commentators trace its evolution to loan practices of the post-Civil War era in the United States. Post-dated checks, on the other hand, have their origin in the era of the Great Depression. In payday lending, there is a relationship with the practice of ‘salary buying’. Salary buying is a credit transaction whereby the lender ‘buys’ the expected salary payment from the borrower at a discount (Chessin, 2005). In the context of Australia, the emergence of payday lending can be traced to the late 1990s. According to (Hughes (2009), the first institution to start offering payday lending services began operations in Queensland in 1998.
Industry size and profitability
In both the US and Australia, there is abundance of literature on how the payday loan transaction is structured and how charges are levied. A typical payday advance ranges between $100 and $500. However, some banks offer loans of up to $2,000. The charges for these loans may be as low as $15 or as high as $35 for every $100 lent. The approval process is simple and it takes a short time. The borrower’s income has to be confirmed as it is the one that drives the lender’s credit limit. The loan has to be repaid within 30 days (Wilson, 2002). In the US, there is an additional provision, whereby the customer can simply pay an additional $15 so as to extend the loan if he manages to repay it within a short turnaround time. In such a case, the borrower is said to have ‘rolled over the loan’ (Lott, 2002). According to Lott (2002), this practice of ‘rolling over’ has played a critical role in generating negative criticism for payday loans.
There is lack of information on whether banks in Australia ‘roll over loans’ for borrowers who repay their loans promptly. Similarly, no studies exist that compare the methods of payment used in the US with those used in Australia. Similarly, data on the industry’s size and profitability is scanty. The only data that is publicly available has been offered by Cash Converters, and it shows an explosive growth between 2005 and 2010 (Cash Converters, 2010). The same report indicates that default rates stood at 3%. This default rates is confirmed by industry and consumer advocacy organizations, they do not specify whether this rate represents monthly or annual figures.
Literature shows that industry data is not very reliable. It is for this reason that the present study aims at adding literature findings with a record of key players in the current economic setting. According to Hughes (2009), the key market players in 2009 included 450 stores across the world, 110 store operators within Australia, web-based cash companies, Pay Mate, Cash Donors, Cash Store, and Payday Online, among many others. Hughes adds that the environment in which payday loans are offered in Australia keeps changing very fast.
Similar growth patterns have recorded in literature from Canada and America, although the industry size in this part of the world is by far larger. According to Thomas (2007), the industry recorded a growth of 525%. This rate is very high compared to that of Australia at 165% between 2005 and 2010 (Cash Converters, 2010). Thomas adds that in these two countries, the banking institutions charged customers 3.4 billion annually in fees alone. Barr (2004) indicates that the return on investment for the industry stood at 24%, while gross margins ranged between 30% and 45% of the total revenue. Such impressive statistics have inspired suggestions to the effect that if this industry operated in the fashion of a single financial institution, it would pass off as one of the largest US banks today. Such a bank would have assets worth $400 billion, which is much higher compared to that of the Bank of America, which stands at $183.2 billion (Lott and Grant, 2002). In the Canadian context, a widely known industry player in payday loans is Money Mart, which has one million customers and annual transactions totaling $2 billion.
The legislative framework
Australian context
There are many State Acts that offer clear guidelines on how the payday lending process should be carried out. In Australia, the Acts date back to the late 1990s following the first-time appearance of payday lenders. One of these pieces of legislation is the Uniform Consumer Credit Code. In this code, state, territory, and national governments were required to equally share the responsibility of customer credit regulation until 2010. Since then, National Consumer Credit Code is being administered by ASIC.
Additionally, there is Uniform Consumer Credit Code (UCCC), which was created after the State and Territories came into an agreement. The resulting Uniform Credit Laws Agreement was aimed at ensuring that there uniformity of consumer credit laws across Australia. Today, many players in the industry regard UCCC as a foundational legislation that lets first-time lenders to be ushered into the mainstream regulation procedures. In the agreement between the States and Territories, the working party was to regulate against the banks’ interest cap. On the other hand, States and Territories were to establish a scheme of regulating consumer credit. This agreement was also instrumental in allowing non-conformity in specific areas. The best example is the situation whereby states and territories can introduce non-conforming laws with regard to licensure of credit providers. Since its formation, UCCC has been strict on disclosure requirements whereby borrowers are warned before any legal actions are commenced. The UCCC also offers a written contract while at the same time ensuring that borrowers will be able to pay off their loans without too much hardship.
In Western Australia, a requirement for licensure has already been added, whereby credit providers are required to comply with the Credit Administration Act 1984. The first state to put in place a 48% cap on credit cost was New South Wales, which it did in 2005. The 2005 act that was passed in the state was essentially an amendment of the Consumer Credit Act (1995). This act required providers to clearly stipulate every credit fee. The same principle was followed by the Australian Capital Territory through the capping of interest rates to 48%, inclusive of all charges and fees. Although Victoria put in place the 48% cap requirement on interest rates, it failed to include fees. This was done through the Consumer Credit (Victoria) Act 2008. Under this law, providers were also required to follow certain registration procedures and participate in external dispute resolution proceedings. In South Australia and Tasmania, reviews of laws were put on hold as these states were awaiting transfer into the Commonwealth.
Literature gives the impression that the UCCC has not been effective in safeguarding vulnerable customers’ interests. According to a 2006 report by the Office of Consumer and Business Affairs of South Australia, it is sad that customers lack the means to defend their rights within the country’s court system. Moreover, although disclosure is not much of a problem today, the documents involves are very complex, making them difficult to understand. Similarly, consumers tend to lack sufficient financial literacy, such that they are unable to look out for better terms from lenders (Lanyon 2004). For such customers, the level of overconfidence about the ability to pay off the loan may be unreasonably high (Ramsay 2004).
A two-phase action plan has already been put in place by the Commonwealth government, in which consumer credit is being regulated using a single, standardized national framework. The first stage of this new consumer credit regime, which was announced in October 2008, entails licensing of credit providers, ensuring their membership in an external dispute resolution program, and setting up a code of conduct. The second phase of this action plan is set for completion by the end of 2011.
US context
In the US, literature shows that the federal government plays a limited role in regulating payday lending. No federal credit rate ceiling has been set and no federal regime exists for payday lenders. One of the few laws affecting payday lenders is the Truth in Lending Act (TILA). However, in the absence of any federal rate ceiling, this act has a minimal effect on the way payday lenders operate. Just like in the case of Australia, TILA requires lenders to disclose all their interest rates and finance charges. They should communicate these fees in both percentages and dollar amounts. Meanwhile, it is interesting how the federal requirements displace state regulation. Although the providers are subject to the legislation of the states where they have been registered, they can export rates into other states where they do business (Lott and Grant, 2002).
Although the federal government has failed to regulate payday loans, this is not an indication of its lack of capacity to do so. Rather, it is because of federal policy choices to let these loans to be governed solely by market forces (Immergluck 2004). In six US states, payday loans are completely deregulated. These states include South Dakota, Wisconsin, New Hampshire, Idaho, Delaware, and Nevada. Additionally, in 31 states, there is a maximum charge that can be imposed on a $100 loan within a period of 14 days. In the remaining 12 states, it is illegal to engage in payday lending (Ellison & Forster 2008).
On the basis of the assessment of payday lending practices in the US, Mann and Hawkins (2007) identify three approaches used to regulate payday lending. The first one is explicit toleration, whereby requirements are clearly stipulated with regard to licensing, disclosure, and ethical lending. Secondly, there is under-enforced prohibition, whereby payday lending is formally prohibited resources to enforce this requirement are insufficient. Thirdly, there is forced prohibition, whereby no payday lending goes on within that state.
Canadian and European contexts
In Canada, Lot and Grant (2002) observe that like in the case of the US, stringent legislation on payday loans is lacking. Strong enforcement is also lacking, mainly because of the impracticality of prosecuting in situations where there are numerous transactions and the amounts being handled are small. This situation also exists because there are many alternatives to payday loans. According to the Canadian Criminal Code, a criminal interest rate is one that is more than 60%. This makes payday loans legal since their charges take the form of fees and not interest.
In the UK, no interest ceiling cap exists (Ellison & Forster, 2008). However, in France, Banque De France centrally monitors the country’s strictly stipulated rate ceiling. Moreover, courts are often called upon to stipulate average rates. A national database has already been set up. This database facilitates credit reference work and the underlying aim is ensuring that the loans improve the financial position of debtors instead of worsening it. In Switzerland and Greece, payday lenders also operate under certain rate ceilings. Such restrictions are absent in Ireland although controls are always put in place whenever financial intermediaries are being licensed. Like in France, Austria courts are often called upon to define rate ceilings, which tend to vary in tandem with the prevailing market interest rates. In Belgium the government periodically intervenes to set the rate ceilings (Manning & De Jong, 2006).
The fierce debate
In the current bibliography, there are two conflicting views. The public view of payday lending has been widely influenced by the media whereby payday lenders have continued to be cast in negative light. Some authors have picked on this negative view and have gone ahead to reinforce it. Over the years, these negative views regarding payday loans have not changed much. In Australia, a commonly expressed sentiment is that these lenders are just ‘sharks’ who are always preying on consumers who are in the low-income bracket. Australian media reports often paint a picture of a lucrative business where reliance is solely on vulnerable customers from whom these lenders extract huge sums of money in terms of ‘fees’. These concerns are often directed towards the high fees charged and customers who are vulnerable, some of who are in a disadvantaged position as a result of being single parents or disabled.
In a study of an electronic database of Australia’s major newspapers, Drummonds (2011) observed that there is an over-representation of consumer advocates’ views of payday lending. Moreover, many stories were found to be driven by emotions, particularly those detailing how recipients of welfare funds plunged into poverty after taking these short-term loans. Essentially, the debate has been between consumer and industry representatives, whereby the key issues include ethics and charges. Consumer protection organizations term the fees as exploitative and unethical, considering their negative impact on the financial wellbeing of disadvantaged people (Wilson, 2002). In response, industry players disagree, insisting that one cannot compare the fixed repayment figure and the short-term nature of such loans to interest. Industry players also insist that these loans are very risky, not to mention the high administration costs involved (Thomas, 2007, Marston &Shevellar 2010).
For authors who reinforce the negative image of lenders, the term ‘predatory’ is now being conventionally used to refer to a wide range of practices that involve very high prices (Karger, 2005). Such authors point out that customers are regularly denied the right to exercise options (Malbon 2005). They also term the lending practices as opportunistic, since they take advantage of the consumer’s vulnerability. Stegman (2007) observes that such practices are so detrimental to customers that they seem like a form of abuse.
Debt spiral and over-commitment
Payday lending industry critics are worried about a scenario known as ‘debt spiral’. In debt spiral, low-income borrowers tend to sink deeper into debt every time they roll over a payday loan. According to Skiba & Tobacman (2008), on any customer who gets approval for a payday loan, on average, applies for some eight more such loans. Elsewhere, Stegman & Faris (2003) observe that the profitability of all payday lenders directly thrives on an increase in the number of chronic borrowers.
Many US studies have shown that repeated business undertaking from the same customers translates into massive profitability for the industry (Flannery and Samolyk, 2005, Stegman & Faris, 2003, Skiba & Tobacman, 2008). A pattern exists whereby a bank ‘borrows from Paul to pay John’, whereby customers keep avoiding renewal limits whenever they alternate between lenders, with the use of funds from one lender to pay off another in turn (Chessin, 2005). In Chessin’s report, it is indicated that two-thirds of the annual loan volume of lenders comprises of customers who borrow during every month of the year, yet these customers make up a mere 33% of all loan borrowers.
Those who defend this industry insist the main problem with these loans is not with the way they are lent out, but rather it is with the borrowers who are always using them (Faller 2008, Huckstep 2007). Meanwhile, very payday lenders take the bother to publish the criteria that they use when lending out their money. However, there are lenders who state that they are only interested in lending to consumers whose income ranges between $400 and 800. Others lend 50% of consumers’ after-tax income, with the minimum loan amount being $500.
It tends to be difficult to ascertain whether the charges can be justified without detailed information regarding the costs of the payday lenders. In other words, it is rather difficult to determine whether the fees are a fair reflection of the costs incurred by the bank, the risks involved, and the short time within which the loan has to be repaid. In a Pilot project embarked on by the NAB (2010), it was found out that loans of up to $700 given out for less than 12 months could not allow for viability of the banking services industry if they were offered on an interest rate of less than 48%. The aim of this pilot project was to assess the viability of different lending models within the fringe credit market. A similar finding was arrived at by Stegman and Faris (2003), who noted that the fixed operating costs of payday lenders are high enough to offer a justification on the rates that the lenders charge.
In the study by Skiba and Tobacman (2007), focus was on seven national lenders in the US and their profitability, whereby their per-store and per-loan costs were found to be very high in the competitive market. However, Barr (2004) maintains that providers get super-high prices, meaning that these profits end up over-covering the expenses incurred, an indication of over-charging. However, there is insufficient empirical data indicating that the payday industry would stop growing if the fees that they levy were reduced. However, literature reveals that the payday loan fees are being sustained at the currently high levels because of poor positioning of customers in terms of access to choices and lack of financial literacy (Lanyon 2004).
Customer profile
There are two major US-based studies: one was funded by the Consumer Advocates and the other by the payday lending industry. These two funders represent the extreme ends of the debate, and their reliability may therefore be questioned. In a Georgetown University study, funding was done by the American Community Financial Services Association. According to Elliehausen& Lawrence (2001).This association has been the representative body for this industry since 2001. In this study, 400 payday loan consumers gave phone interviews. The Georgetown Study defines the typical payday loan beneficiary as a working, middle-class person who perceives value in payday loans, and makes use of them infrequently, in most cases after being befallen by an emergency. Such a customer is married, has children, is aged below 45, and has attended college. The majority of these consumers also have a family income ranging between $25,000 and $50,000. These findings are consistent with those of Stegman and Faris (2001), in which the researchers found out that North Carolina payday lenders are mainly ‘moderate income’ earners whose income is between $20,000 and $40,000. In the study by Stegman and Faris (2001), such consumers tended to borrow more than those who earned an average of less than $20,000.