Consumer Credit Availability and Financial Exclusion in Australia
Forced Competition for Competitive Payday Loan Rates?
Legislators from various nations have proposed that control over consumer credit become centralized, i.e. placed under control of the national government rather than continue to reside with states and principalities. Their reasoning is that if they can provide the traditional banking sector with enough incentive to offer small loans like payday loans at competitive rates, the venture would be profitable and consumers would be protected from predatory lending schemes.
Australia appears to think this is a good idea, as upcoming legislation will enact such payday lending control. Lecturer Nicola Howell of the Queensland University of Technology theorizes in her 2009 paper “National Consumer Credit Laws, Financial Exclusion and Interest Rate Caps: the Case for Diversity Within a Centralised Framework” that centralized credit regulation could be a good thing, but doesn’t fail to notice the potential for major problems that throttle consumer choice when it comes to small loan access.
What Will Happen in Australia, Exactly?
Australia will transfer consumer credit control from State and Territory Governments over to the Commonwealth. The goal is for a uniform system to regulate consumer credit and form a “seamless national regime.” The assumption is that the change in regulatory power will result in greater responsiveness to the dynamic market, which was greatly desired after experience with the “slow pace of change in the current State and Territory-based regime.”
But Financial Exclusion is Not Addressed
Some in Australia welcome this change, but Howell argues that the change will not sufficiently address the issue of financial exclusion. Howell defines financial exclusion as “the lack of access by certain consumers to appropriate low cost, fair and safe financial products and services from mainstream providers.” This means small loans and payday loans. Centralized consumer credit regulation, Howell fears, could create interest rates that make it impossible for many payday loan lenders to operate. This in turn would limit consumer credit options. “There is an absence of any consideration of regulatory initiatives that might encourage the availability of low cost, fair and safe small loan products,” writes Howell.
But Howell Feels a Cap is Necessary
Ample evidence exists that using rate caps as a regulatory tool affects consumers negatively. Here’s one of many examples. Howell admits that “total centralization of consumer regulation does pose some risks for consumers, by way of potentially reduced standards, and reduced opportunities for regulatory experimentation and local responsiveness,” so the potential for danger is recognized. Perhaps that’s why “permitting regulatory diversity on interest rate caps” in case consensus cannot be reached on where to set the rate cap bar is on the author’s mind.
No to Financial Exclusion of Essential Products
The authors states (and is definitely not alone in this regard) that the products consumer credit markets offer for cash emergencies – such as payday loans and other small loans – are as essential to well being as utility services like electricity and water. Thus, efforts should be taken to maintain their availability to the public. Keep payday loans available and affordable; don’t cap them to the point that payday lending businesses have to close their doors, costing communities jobs as well as options for credit.
If designed properly, a rate cap could indeed regulate prices without squelching choice. But the kind of APRs most legislators talk about (whether it is Australia or America) can typically only be swallowed by large institutions, i.e. traditional banks. Thirty to 40 percent APRs work for companies already rich with capital, but not for smaller payday lenders. Consumers go to such lenders because they can’t crack the surface with traditional lenders like banks, frequently because of credit issues. If their main credit option for emergencies and smoothing consumption shocks is taken away, what are consumers left with? That would be loan sharks and similar dangerous options.
In their efforts to stay alive when faced with shortsighted regulation, some payday lending companies have found ways to circumvent unfair rate caps. Since payday loan companies are not raking in excessive profits to begin with and it’s been proven that small loans can’t work under restrictive rate caps, Australia should take notice. Unless they don’t mind hurting their citizens, that is.
Learn from America’s CRA Disaster, Australia
Howell compares Australia’s Commonwealth coaxing banks to enter the payday loan market to what the Community Reinvestment Act (CRA) did for the housing market in the United States. While the CRA was designed to “encourage depository institutions to meet the credit needs of their communities, including the needs of lower-income consumers and neighborhoods,” writes Howell, the reality is that their strong-arming efforts helped produce the subprime mortgage mess that nearly destroyed America’s economy. Along with ACORN, the Community Reinvestment Act (CRA) sought to curb redlining, but what they achieved is that they convinced lenders to relax their lending standards so much that they began lending and granting mortgages to people who couldn’t possible repay. As the Wall Street Journal put it, ACORN and the CRA “laid the foundation for the house of cards built out of subprime loans.”
Will the Commonwealth Sweat Banks Under the Hot Lights?
The CRA “required banks to increase lending in low-income neighborhoods.” Enforcement terms were vague, but in practice it meant that ACORN and the CRA could pressure banks into subprime lending because doing so somehow fought against racism. American lenders that didn’t comply were threatened with me branch expansion, mergers and acquisitions being blocked. ACORN and the CRA could effectively shut a bank down if they didn’t comply. Is that what Australia really wants to do to its banking system and its consumer base? I’m surprised Howell missed this notorious piece of American financial history, being a professional researcher.
Empowering the Consumer
Here’s a more reasonable line of thought that Howell touches upon: “Rather than imposing price regulation,” she writes, “competition between lenders should be encouraged, and consumers should be empowered to choose the most appropriate products for their needs.” Yes, on this we can agree, as well as on the fact that “centralization and uniformity in law is not necessarily always beneficial” for said consumers. Who is to say that uniformity would automatically lead to the greatest standards? Europe can weigh in on this, as Bourgoignie and Trubek state in their 1986 study “Consumer Law, Common Markets and Federalism in Europe and the United States” that
Once again, it must be stressed that uniformity does not necessarily advance consumer interests… There is a possibility that uniformity will be used to cut back consumer rights.
Cut back consumer rights? Is this necessary for Australia? Is it necessary anywhere? Consumers aren’t forced to use payday loans, but they do because of a speed and convenience that traditional banks and credit unions can’t match.
“There Are Potential Risks,” Says Howell
“In the context of interest rate caps,” she writes, “these risks, together with the fact that it is likely to difficult to find a consensus approach, or to conduct a comprehensive analysis of the relative merits of the different approaches within the reform timeframe, suggest that there may be some merit in permitting diversity on interest rate caps to remain, at least for an interim period.” This, Howell postulates, could help minimize financial exclusion. Since the Australian Commonwealth’s current proposal doesn’t address this potential harm to consumers, it is advisable that rash action not be taken to cap interest rates too low. This is where Howell’s diversity comes into play around the APR cap. Australian consumers who are more vulnerable to financial shocks should have the option to use payday loans if the traditional banking system fails them.