The bad business of payday loans

Payday loans from banks pose huge problems for poor consumers – and the banks themselves. The federal government has finally stepped in with new guidelines for payday loans.

Robert Galbraith/Reuters/File
A woman walks past teller machines at a Wells Fargo bank in San Francisco last month. Wells Fargo is one of the bank chains offering deposit advance loans, essentially payday loans.

In an effort to curb abusive lending practices, the US government has finally issued guidelines – long overdue – on short-term bank loans tied to consumers’ income. The new federal limits will help to protect consumers and, surprisingly, the banks who make such loans.

The benefit for consumers is obvious. These deposit advance loans (which are really just payday loans offered by legitimate banks rather than shady neighborhood dealers or online outlets) hit consumers with a myriad of expensive fees and charge up to 120 percent in interest. The new guidelines, issued last month by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp., rein in the interest rates that banks can charge and the balloon payments they require.

Here is how the loans work: A bank advances money to existing customers against their paycheck, Social Security, or other benefit that is due to be deposited into their accounts. When the expected deposit hits, the bank withdraws its principal plus interest directly from the account.

So far, such an advance could be construed as a valuable service for cash-strapped consumers. Deposit advance lending exists because some people cannot meet their near-term financial obligations and need a little extra time to round up the necessary funds.

The problems start, however, when the deposit cannot cover the full amount of what the customer has borrowed. The bank takes its money anyway, and socks the borrower with overdraft fees and additional interest.  Since people who need these advances are invariably low income and struggling to pay their bills in the first place, these fees and interest charges quickly build up and can create a growing and never-ending cycle of debt.

But the practice is problematic for the banks, too. They do not typically do a credit check for deposit advance loans, which means they cannot assess the real risk of lending to such borrowers. Plus, high interest loans can easily push borrowers with bad credit further into the red and render them unable to pay back the bank. Free enterprise is not a license for irresponsibility and there are few business practices worse than lending to unqualified borrowers at high rates.  The outcome is predictable and ultimately runs to the detriment of both the borrower and the lender.

To see evidence of this, look no further than the subprime mortgage crisis of 2008, which began with mortgage loans to unqualified borrowers and ended in mass foreclosures and the widespread destruction of wealth.  While in that case banks and mortgage originators were able to offload most of their risk onto quasi-governmental agencies like Fannie Mae and Freddie Mac, there is no such safety net for deposit advance loans. 

It is also worth noting that the investment banks that bought the bad mortgages in order to securitize them and sell them to outside investors profited at first but eventually took massive losses when the loans went bad and the insurers who had backstopped them could not pay up. The moral of the story is that whenever lenders fail to assess true risk or actually compound that risk through onerous terms, the results are bound to be bad.

That’s why the new federal guidelines should help banks. They require banks to moderate the fees and interest on their loans to avoid increasing the chances of default and, equally importantly, refrain from lending when consumers show patterns of delinquency. It’s sad that in a free enterprise system the federal government has to step in to save the banks from themselves, but when lending bubbles can cause the type of havoc we witnessed in 2008, and when respected banks like Wells Fargo (Ticker: WFC) and U.S. Bancorp (Ticker: USB) choose to ignore the risk of offering dubious products like deposit advance loans, what choice is there?

For a list of the banks who do this and their respective terms, click here.

– Political and business commentator Sanjay Sanghoee has worked at leading investment banks Lazard Freres and Dresdner, as well as at multibillion-dollar hedge fund Ramius. His opinion pieces have appeared in Time, Bloomberg Businessweek, Fortune, and Huffington Post, and he has appeared on CNBC’s ‘Closing Bell’,, and HuffPost Live.

You've read  of  free articles. Subscribe to continue.
Real news can be honest, hopeful, credible, constructive.
What is the Monitor difference? Tackling the tough headlines – with humanity. Listening to sources – with respect. Seeing the story that others are missing by reporting what so often gets overlooked: the values that connect us. That’s Monitor reporting – news that changes how you see the world.

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to

QR Code to The bad business of payday loans
Read this article in
QR Code to Subscription page
Start your subscription today