The MidwesterThe MidwesterThe MidwesterThe MidwesterThe Midwestern Ofn Ofn Ofn Ofn Office of The Council of State Goverfice of The Council of State Goverfice of The Council of State Goverfice of The Council of State Goverfice of The Council of State Governmentsnmentsnmentsnmentsnments VVVVVolume 7, Number 10 • November 2000olume 7, Number 10 • November 2000olume 7, Number 10 • November 2000olume 7, Number 10 • November 2000olume 7, Number 10 • November 2000

FirstlineShort-term lending falls under scrutinyof lawmakers and regulatorsby Laura A. Tomaka

Consumer Protection,part IIWe continue a look atstate efforts to addressconsumer protection byexploring recent activitiesto guard against identitytheft.

Next month:

Whether correctly viewed as awise choice in managing a

short-term cash flow problem,or the first step into a

downward spiral of ever-increasing debt, payday lendinghas caught the attention of state

lawmakers and regulatorsacross the region and the

nation.

The loosening of federal banking andfinancial regulations in the 1980s,which in part intended to help thebeleaguered savings and loan industry,has paved the way for the develop-ment of a new facet of financialservices that currently is receivingboth criticism and scrutiny.

These “alternative financial services,” or“fringe banking” services as they are alsocalled, include check cashing outlets,payday loan companies, high-cost secondmortgage companies, sub-prime autolenders, and auto title pawn companies.

The leader in alternative financialservices is the payday lendingbusiness, which has blossomed into abillion dollar industry. In 1992, therewere fewer than 300 such lendingoutlets nationwide. Today, estimatesindicate that there are more than9,000, with about 100 new locationsopening each month. This phenom-enal growth in the payday lendingindustry is being matched by anincreased call for regulation to giveconsumers greater protection.

As the name suggests, payday lendingprovides, for a fee, small, short-termloans (typically $100 to $300) to helpa borrower through a temporary cashflow problem until the next payday. Apostdated, personal check for theamount of the loan, plus a fee, is the

only necessary collateral.

These loans carry high interest ratesor fees. It is not unusual for a paydayloan of $200 to carry fees of $25 to$40 — or 15 to 20 percent. Thesefees are a central part of the criticismleveled by opponents of what theycall a “predatory lending” practice,likened to legalized loan-sharking.Critics view the industry as exploit-ative of people in desperation andtarget those who can least afford therates being applied.

Industry representatives and support-ers argue that the growth in thepayday advance industry is the resultof market demand for a serviceunfulfilled by conventional banklending. Proponents further bolstertheir arguments in favor of theindustry with evidence of highcustomer satisfaction and relativelyfew formal complaints being madeagainst payday lenders.

Whether viewed as a wise choice inmanaging a short-term cash flowproblem, or the first step into adownward spiral of ever-increasingdebt, payday lending has caught theattention of state lawmakers andregulators across the region and thenation who wish to provide safe-guards against an industry often seenas taking advantage of a vulnerablesegment of the population.

Firstline

Consumer protections are sought for payday lending industry

November 2000

The current trend in legislative andregulatory action concerning paydaylending has focused on efforts toincorporate consumer protections intothe statutes and regulations underwhich the payday lending industryoperates.

In ILLINOIS, where over 600 paydayloan stores have opened since 1997,several pieces of legislation dealingwith the regulation of short-termloans were considered this pastsession — none of which weresuccessful. These measures includedprovisions that would have estab-lished limits on where paydaylending outlets could locate, licensureprovisions, interest rate caps, as wellas other consumer protections.Illinois currently has no statutory orregulatory limits on fees.

A successful measure, however,

directed the Department of FinancialInstitutions to consider new rulesguiding short-term lending in thestate. The department issued its finalreport, along with recommendationsfor new regulations in October.

Among other things, the departmentrecommended rules that wouldrequire borrowers to wait for a periodof 30 days between negotiatingadditional payday loans, and wouldalso establish a statewide database toprevent customers from taking outloans from multiple outlets. As a wayto further curb consumer debtescalation, only two refinancings orrollovers would be permitted on asingle loan.

Despite strong support from Gov.George Ryan, consumer and civicgroups and clergy members — all ofwhom have been concerned about the

impact of the high cost of the paydaylending practice on low-incomeconsumers and the elderly — theproposed regulations have been metwith resistance among the industry’scustomer base in Illinois, arguing thattaking advantage of payday advanceservices is a matter of individualconsumer choice.

While WISCONSIN does licensepayday lenders, it is one of less than10 states that does not cap the ratesor fees on payday lending.

Driven by franchised chains, thegrowth in the popularity of paydaylending has brought increasedscrutiny. Two years after the industrywas introduced to Wisconsin in 1993,the state had 17 licensed paydaylenders. By August 2000, the state’sDepartment of Financial Institutionsreported 195 licensed outlets. In1999, 850,000 of these short-termloans were issued, totaling about$200 million.

State policymakers, however, are splitover the issue of regulation andlegislative efforts have not beenfruitful. While some lawmakers andthe attorney general’s office havepushed the issue recently, the state’sDepartment of Financial Institutionshas not called for new regulations.

Some legislators want to implementnew limits on the loans in order toprevent consumers from being“unknowingly gouged.” A bill thatwould have placed a 36-percentannual cap on interest rates on payday

There are more than 9,000 payday advance outlets nationwide, and it isestimated that 100 new locations open monthly. In 1999, the industry tookin $1 billion, and that amount is expected to reach $2 billion in 2000.

The typical payday loan ranges from $100 to $300 and carries a feebetween 15 to 20 percent.

Twenty-four states currently allow some form of payday lending; eighthave no limits on fees.

Nineteen states exempt the industry from limits on interest rates; 18states have caps under their usury laws.

The average payday advance customer is about 35 years old, has anannual income between $25,000 and $35,000, has been in his or hercurrent job for about four years and has resided in his or her currentresidence for over four years. Nearly two-thirds of the borrowers rent theirhomes and nearly two-thirds are women.

Sources: Federal Reserve Bank of Minneapolis; Community Financial Services Association ofAmerica

QUICK FACTS

OHIO, which already limits paydayloans to a maximum of $500 andallows no rollovers, joins MINNESOTA

in having some of toughest restric-tions in the region. In Ohio, thepayday lending industry grew fromless than 90 outlets in 1997 to nearly450 in 1999. Last fall, several Ohiolegislators convened public hearingsto further explore the merits of theindustry, but no legislative action wastaken.

Firstline

Laura A. Tomaka is a program managerwith CSG Midwest.

loans died in the Legislature this pastsession. Likewise, another measurethat would have required consumereducation for those consideringtaking a payday loan died in theAssembly this past session.

The state’s attorney general is alsocalling for consumer protections bysupporting limits to the amount of aperson’s paycheck that can be used tosecure such loans.

INDIANA’s payday lending industry,which is restricted to a $33 maximumfinance charge on each transaction, isin a state of flux. In January, the nowformer attorney general had issued anopinion that the payday lendingindustry was in violation of the state’sloansharking statute due to theexorbitant fees attached to the service.

The ruling, along with a pendingclass action lawsuit, also helped toeffectively stall legislation introducedearly in 2000 to enact a “deferredpresentment” statute, which wouldhave capped the fee on loans up to$500 at 18 percent and limitedrollovers to three.

In 1999 MICHIGAN’s top prosecutoralso weighed in on the payday lendingdebate in that state when the attorneygeneral declared the short-term loansillegal. A 1999 bill, however, is stillpending that would make the paydaylending industry legal. Similar to theIndiana deferred presentment bill, thatmeasure would have also put an 18-percent cap on loans for up to $500,with a limit of four rollovers. Similar

legislation is expected to be introducednext session.

In other official actions againstpayday lending, the NORTH DAKOTA

Banking Commission had sent cease-and-desist orders to pawnbrokerswho were illegally issuing paydayloans with fees in violation of stateusury law. North Dakota does notlicense payday lenders, but it doesissue consumer finance licenses withfee caps such that a company canlend up to $35,000, the first $1,000of which has a maximum annualpercentage rate of 30 percent.

This year, the Community Financial Services Association of America(CFSA) — the industry’s only trade association — released a set of“best practices” to serve as self-regulating standards for the paydaylending industry. The association, which wants to reduce customerabuse through this code of conduct and supports limited regulations onpayday lending, requires its members to adhere to this set of standardsas a condition of membership.

CFSA’s best practices include: full disclosure of contract terms; compli-ance with all applicable laws; truthful advertising; encouragement ofcustomer responsibility; limit or prohibition of rollovers, compliance withstate laws; customers’ right to rescind the transaction; non-threateningand noncoercive collection practices; rejection of criminal action againstcustomers as a result of returned checks; and voluntary reporting ofviolations of the Best Practices.

Critics of the industry contend that CFSA’s best practices are anattempt to stave off legislative and regulatory action through a show ofself-policing. CFSA and industry proponents counter that the policies arean important step to ensuring consumer protection, while allowing thebusiness to thrive.

In addition to the association’s requirement that members uphold thebest practices, CFSA is in support of “reasoned” legislation and regula-tion of the industry by states. This year, Arizona and Colorado bothpassed legislation that imposes new regulations on the payday lendingindustry in their states, including limits on fees, licensure requirementsand limits on rollovers. These measures, which incorporate elements ofCFSA’s best practices, are being held up by the many payday lendersas “models” for moderate regulation of the industry.

Industry strives for self-policing, supports regulation

Source GuideFor more information on payday lending and fringe banking:

American Association of Retired Personswww.aarp.org

Community Financial Services Association of Americawww.cfsa.net (phone: 202-367-1142)

Consumer Federation of Americawww.consumerfed.org (phone: 202-387-6121)

Consumers Unionwww.consumer.org (phone: 914-378-2000)

Federal Reserve Bank of Minneapolis’ Fedgazettewoodrow.mpls.frb.fed.org (phone: 612-204-5000)

Payday and Paycheck Loans Consultingwww.paydayandpaycheckloans.com (phone: 949-369-5435)

November 2000 November 2000 November 2000 November 2000 November 2000Midwestern Office ofThe Council of State Governments641 E. Butterfield Road, Suite 401Lombard, IL 60148-5651Phone: 630-810-0210Fax: 630-810-0145E-mail: csgm@csg.orgwww.csgmidwest.org

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Permit No. 210Freeport, IL

Limits on Payday Advance Fees

State limits payday advance fees

State does not limit payday advance fees

Legislation pending