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Expensive but not excessive: why payday lenders aren't a ripoff


00:00 EST Tuesday, February 12, 2013    

Every so often payday lenders make the news, and the coverage is predictably unflattering: these small seedy storefront shops charge exceptionally high rates and take advantage of the poor and desperate.

Stories last week on the province of Ontario's attempt to revoke the licence of Edmonton-based The Cash Store Financial Services Inc. fit that mould.

While it's tempting to look down upon this kind of lending (including the Cash Store's practice of upselling recipients on optional services to receive their cash, which appears to have prompted the province's action), it's important to remember what payday lenders are, and what they are not.

Payday lenders are not banks, nor are they loan sharks. Unlike the former, they actually provide small, short-term loans - typically of a few hundred dollars - to people, without performing rigorous credit checks. Unlike the latter, what they do is legal and regulated, and defaults don't result in broken kneecaps.

They are also not federally regulated: Ottawa in 2007 downshifted oversight to the provinces, which hardly coveted the responsibility. It's easy to see why politicians abhor payday lenders and treat them like bogeymen: They don't want to be associated with institutions that charge extremely high fees for short-term loans, often to those in desperate need of a tide-over.

Federal usury law prevents lenders from charging more than 60 per cent interest, but makes an exception for short-term loans, leaving it up to the provinces to cap the amount charged. Maximum fees per $100 lent range from $17 in Manitoba to $29.85 in New Brunswick; in Quebec all payday lenders are banned outright. But even at those capped rates, a two-week loan can yield annualized payments of more than 500 per cent. It's little wonder provincial regulators and class-action lawyers have been gunning for these lenders for years.

Perhaps more significantly, payday lenders are not extremely profitable. Those high rates are a reflection of the higher returns these operators require to compensate them for the higher costs and risks they take on. Payday loan delinquencies, according to a 2009 survey by Ernst and Young, account for 8.4 per cent of the total, about eight times higher than for credit cards and 15 to 30 times more than loan loss provisions for Canada's banks. Even after recoveries, payday lenders must make do with loan losses in excess of 3 per cent.

Their cost of capital is also much higher and opportunities for economies of scale, given the modest size of the industry, much lower. A 2009 report for the Ontario government by an advisory board found "payday loans are expensive because of their design as small, short-term loans, not because the industry is earning excessive returns."

Cash Store Financial, which is facing other issues, lost money in its most recent quarter, while its better-run rival, DFC Global Financial, with about 490 Money Mart branches in Canada, earned an average pretax income of 15.4 per cent on revenue of more than $300-million in each of the last two years - a full 10 percentage points lower than the big banks.

But like them or not, payday lenders do play an important function in society: as niche, legitimate providers of credit to people with credit challenges (loans are typically approved only to people with a source of income, and many of those earn middle-class incomes) and as a quick and convenient source of moderate amounts of cash.

It would be preferable to see these customers find better alternatives, but without payday lenders, that list would include much bleaker choices.


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