Monday, May 18, 2009

World Needs Payday Lending

Payday Lending is one of the most discussed topic in Finance Industry for many months, and most of the thoughts have come against it. Being a Analyst with Interest in Subprime Lending and smaller Loans, I was looking at these market developments.

Here are few of my observations:
1. Lender's Greed went uncontrolled
There are various players in the US Market who are actively into Payday Lending. There were people who entered the market with long term Marketing Strategy while others went to make quick money. These later class had too much of greed, and were charging around 720% to 800% APR, annualized percentage interest rate (30% for 15 day cycle + administrative fees). This is certanly too bad to do any good to the market.

2. Market moved from Bad to worse
The very high interest rates forced more people to become bad, and default on their loans. This piled off huge debts on the individuals who used payday loan. This again made them not laible to Payday Loan too, and moved them from Underbanked to Unbanked Mass.

3. Early Movers Made Money, Late Movers Died
Early movers made huge amount of Money. They capitalized on the urgent need of cash for utility bill payment and others for underbanked population, and build a good customer base. As the market was raw, they got chance to exploit its full potential. 

The advantage of the early movers were the lack of intentional fraudsters in the market, and the monopoly to choose best leads. As the competition increased, the market was exposed to many fraud cases along with high risk of giving loan to less credit worthy leads. This was coupled with more people being moved from good to bad with the imposition of very high interest rates.

4. Use of Data Made Kings, others make their way out
There are certain companies which went out of the market citing great loss, and others like are still the kings. They have huge portfolio of around $50m in a market where the profitability of close to 10-20% Monthly. All thanks to proper database maintence and use of Risk Management Practice.
They not only used their data to lower risk, but also used to retain the good customers.

5. Payday Lending is a Risky Game, High Interest Rates are inevitible
The market of udnerbanked and unbanked where Payday Lenders actually target is a very risky population. It has very low credit worthiness, and the credit rating cannot be done due to thin file accounts. This make the Risk Management Task very challenging.

More pain is added by the lack of information to have good Fraud Model too. The portfolios of various clients, which I have seen so far have an average bad rate of 15% to 40%. This is after the Risk Control measure. When I made an analysis to predict the Bad Rate of random population, it came around 85%. 

So if you look at these statistics, you will know how important it is to charge high Interest Rates. I feel Interest Rate of around 120% APR (5% for 15 days) is reasonable, and it can go upto 240% APR.

6. Payday Lending is necessary, World got it wrong
Payday Lending is blamed for distubing the market by many activists and serious bankers. They do have some point, but all they say does not hold true.

When I miss a credit card payment, bankers charge me huge amount. Once I missed a payment of Rs. 800 and the bank charged me Rs. 1400!! It includes interest rate and late fee. Had I taken loan for Rs. 1000 and paid it, it would have saved Rs. 1,100 after paying the interest rate of 30% for 15 days.

So a serious question to be answered, is Payday Lending a real monster? Or is it a blessing in disguise? I would not be surprised if someone prove the hand of big Banks in the movement against the payday loans. Afterall they lose huge money in administrative fees if people pay the EMIs and Credit Card Installments on time.

It is also coupled with teh loss of govt. agencies and other companies. People have option of taking a payday loan immediately and pay the utility bills on time to avoid the administrative fees.

My Take:
Payday Lending Loans can be taken under Smaller Loans Act, and the interest rates needs to be capped. But the cap rate should be 240% and not 36%! No Payday Lender can live at 36%, and authorities need to undnerstand this ground reality.

General public will lose an option to not pay the hidden fees of big banks, if payday lending is abolished. This is not in bigger interest of the nation.

Instead Market needs to be left free hand (ofcourse with CAP) to function, and the competition will bring the interest rate down. Good Attritors will be retained and this retention is not possible without lowering the interest rates. The new and the risky might have to pay high rates, but thats fine as they will get cheaper loans with time.


Fred Cash said...

Wow, thanks so much for sharing this post and your insights. It's good to hear other say that the 36% cap is not fair and will hurt the industry. I think your proposal of 240% is a lot more reasonable and will provide a good benefit for all parties. What many people don't understand is that the fee is just a one time payment and there are not installment payments for the lender to make money on. They have to make their money on a one-time service fee and if they only make pennies on the dollar, they will not loan money out or set the minimum so high that many people will not get them at all. That in turn could hurt the industry, lose jobs, worsen the economy, and take away one of the only loan sources for many people who would wind up filing bankruptcy, which would hurt more in the long run. Thanks for sharing your thoughts.

Bhupendra said...

Hi Fred, Thanks for the good words. Cant agree with you more.


Shweta Sharma said...

Well said.I couldn't agree more with you. Lending of any kind could be a friend or a foe depending on the way it has been granted. Payday lending is no exception. The risk involved with Sub prime lending is inevitable unless proper rule based decisions are taken. Oh data, we hail thee!!

colegrath said...

At least someone gets it, even if it isn't necessarily in America. People need as many financial options as they can get. Their needs are all different and they need the avenues and education required to make the best use of them.

emilywinkle said...

While almost everyone is eligible for a payday loan, payday loans are to be used only in emergencies. When the alternative to not paying for what you need is worse than taking out a short-term loan to pay for it. Visit for more information.

Kim Roach Presents "Instant Payday Formula" said...

Kim Roach Presents "instant payday formula"

Small Business Loans said...

Thanks for the post, we will post your business card article. I will post for our customers to see your articles on your blog. Small Business Loans

Page Views from May 2007


© New Blogger Templates | Webtalks