Risks with Payday Lending

Like everything associated with life, payday lending has its risks. The payday lending business has presented new growth opportunities for banking, but it also presents a much greater risk as well. Higher prices on payday loans can promise higher revenues and wider margins for lenders, this is for sure. The draw back is the much greater risk that is associated with payday lending. The most prominent being the high credit risk, which even when compared to other types of unsecured subprime lending like credit cards, doesn’t even compare. There are significant differences between the techniques used for subprime credit card lending and payday lending that causes payday lending to be among the highest risk separations of subprime lending. Payday guarantee requirements are substantially less than those required by credit card lenders. They (credit card lenders) often complement a prospective borrower’s credit bureau report with additional information such as income, employment history, the nature of prior credit problems and other related questions. The reigning criteria of most payday lenders require that consumers only need proof of a documented regular income flow, a personal checking account (which is fairly easy to get these days with only an ID proving you’re over eighteen and maybe a small deposit, which is not always required) and a valid personal identification to receive a payday loan.

Data for credit check and credit quality for specialty payday lending entities is lacking especially because most payday lenders are small, non-publicly traded firms. A review of some publicly traded company reports show that some payday lenders (those being specialty payday lenders) have recorded quarterly annualized net charge-off ratios (generally known as the APR or what the bank or lender makes off the loan) as high as 83%, which is far higher than the typical annualized net charge-off ratio for subprime credit card lenders. One would expect credit card lenders to have the higher of the two, but after examining all the factors that go into both of them, I think you would reconsider your first assumption. Most recent charge-off ratios for subprime lending institutions credit card portfolios do not generally exceed 20%. Default rates that are higher for payday loan portfolios indicate that loan loss may be ample for some; other forms of subprime lending may not suitably cover the increased risks associated with payday loans.

Depository institutions that are involved with payday lending may also enter arrangements with third parties to initiate the payday loans. Some of these loans will more than likely involve fees and charges in surplus amounts of those that the third party could otherwise charge under state law. Although federal banking decrees authorized insured depository institutions to “export”, per say, interest rates from states where the lender is located on loans made to the borrowers who reside out of state, legal action involving the use of this authority by third-party payday lenders has recently increased. Among all of this, some suits also have allegedly had lender violations of various state and federal consumer protection laws that are in connection with these loans. Therefore, participation in these arrangements may cause exposure to the insured depository institutions to substantial legal and reputable risks. Third-party arrangements may also pose as additional operational risks, these being heightened risk of transactional error or even fraud.

This sounds like a lot of legal jargon, I know. It is really very simple though to understand. The insured depository institutions, otherwise known as banks,