‘Payday Loans’: An Ethical and Socially Responsible Industry? Eighth Alternative Perspectives on Finance Conference Zakopane, POLAND August 6 – 8, 2006 Mark S. Schwartz School of Administrative Studies Atkinson Faculty of Liberal and Professional Studies York University 4700 Keele Street Toronto, Ontario M3J 1P3 CANADA Phone: 416-736-2100 (ext. 20124) Fax: 416-736-5963 E-mail: schwartz@yorku.ca Chris Robinson School of Administrative Studies Atkinson Faculty of Liberal and Professional Studies York University 4700 Keele Street Toronto, Ontario M3J 1P3 CANADA Phone: 416-736-2100 (ext. 20097) Fax: 416-736-5963 E-mail: crobinso@yorku.ca
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‘Payday Loans’: An Ethical and Socially Responsible Industry? While short term loans have been available in one form or another for ages, a formal „payday loan‟ industry, as distinct from the banking industry, has begun to emerge around the world. The industry primarily involves the provision of an unsecured, small short-term personal loan based on one‟s future pay check. Despite its significant growth however, the industry has only recently become scrutinized, despite flagrantly violating legislation in many jurisdictions which prohibits the charging of excessive loan rates. While several studies have examined the ethical nature of usury (see Lewison, 1999), to better examine the nature of this particular new industry, we will attempt to discuss whether the industry, in its current practice, is both ethical as well as socially responsible. An historical overview of payday loans helps inform the analysis. Beginning with Biblical and Islamic laws against usury (leading to the prohibition of usury by the Catholic Church in 1139), society has become over time much more accepting of charging interest to others. Beginning with European Jewish money lenders and merchant bankers, much of the Christian world began to accept the necessity of charging interest for loans. Eventually pawn shops, car title lenders, rent-to-own stores, loan sharks, and even banks through overdraft protection, began to fill the demand for small short term loans. More recently, a formal payday loan industry has begun to flourish, now generating $320 million (CDN) in revenues per year in Canada. There are approximately 300,000-400,000 Canadian customers who take out at least one payday loan in a year from over 1,000 retail stores across Canada, with the volume of loans amounting to approximately $1.7 billion (CDN) (see Ernst and Young, 2004). In the United States, there were approximately 22,000 payday lenders in 2004 extending more than $25 billion (US) in short terms loans to millions of households (Karger, 2005: 6). Internet payday lending also continues to grow, although no studies on the actual extent of this activity appear to exist. The industry is also well-established in the UK, where Money Shop is the largest payday lender. Money Shop and Canada‟s largest payday lender, Money Mart, are subsidiaries of the Dollar Financial Group Inc. of the US.
What is a Payday Loan? A payday loan is an unsecured, small short-term personal loan. The principal is $50 to $1,500, though most loans appear to be in the range of $50-$500. In Canada, the lenders allow loans up to 50% of the next paycheque. The term is one day to 31 days, though most are for 14 days or less and some lenders will not lend for longer terms than that. The prospective borrower must have an employment record and a bank account on which to write cheques. The lender does not perform a credit check. Many of the borrowers could not pass a credit check, but in any case the cost of even the simplest credit check is too high in the context of payday lending. The security for the loan is the evidence of a regular job with a known future pay. The customer fills in the standard application and signs it, gives the lender a cheque for the principal plus all fees and interest, dated on the next payday, and receives either cash or a direct deposit that s/he can access immediately.
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The fees and interest charged are extremely high. Different format exist:
A fixed fee + a fixed percentage of the principal + interest for the period of the loan. E.g. Money Mart in Canada charges $2.49 + 59% interest (where interest is
calculated using an effective annual rate of 59%) + 13.99% of (principal + interest).
A fixed percentage of the principal + interest for the period of the loan. E.g. Cash Store in Canada charges 26% of the principal + $8.00 for the first time customer to get a debit card + $6.00 for each loan to draw the money from an ATM + the interest rate charged by the lender to whom the loan is brokered. A fixed percentage of the principal, regardless of how long the loan is outstanding. E.g. many smaller payday lenders in Canada charge 20 or 25% of the principal of the loan; the state of Montana in the US allows a maximum rate of 25% of the principal, but only on loans not exceeding $300. A fixed percentage of the first $x of principal + a lower fixed percentage of any principal in excess of $x. E.g. Indiana allows 15% on the first $250, 13% on the next $150 and 10% on the rest, up to a principal of $500.
The effective annual rate (EAR) varies widely, particularly because of the short term of the loans and the fact that most of the fees are fixed. On typical loans of 12 days, the EAR is in the 10,000% range. For small loans for short periods, the EAR can exceed 1 million%
Corporate Social Responsibility Assessment of the Payday Loan Industry While there are many different CSR frameworks available to use in analyzing business activities, we use the “three domain model” of corporate social responsibility as proposed by Schwartz and Carroll (2003) to analyze and assess the economic, legal, and ethical domains of this newly emerging industry. Their framework rejects the philanthropic domain, unless the philanthropy is based on the economic or ethical domain, a position we agree with. The lack of information on philanthropic activity within the payday loan industry also suggests that it is not amenable for analysis. Economic Domain. According to Schwartz and Carroll (2003), for the purposes of their three domain CSR model, the economic domain captures “…those activities which are intended to have either a direct or indirect positive economic impact on the corporation in question. The positive impact is based on two distinct but related criteria: (i) the maximization of profits; and/or (ii) the maximization of share value. Any activity that is pursued with improving profits and/or share value in mind is deemed to be economically motivated.” Assessment: There is no question that the pay day loan industry operates clearly within the economic domain. All of their actions appear tied to the maximization of profits and/or share value. Some specific examples:
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As the industry has expanded rapidly in Canada, we would expect to see some competition on fees charged. The contrary has happened. Money Mart has raised its fees twice in two years, by significant amounts. At the same time, Cash Store, the second largest firm,1 has also raised its rates considerably, and when it took over a large competitor, it raised the rates at the converted stores. Money Mart would allow a borrower only 30% of pay as a loan for a long time. As the competition increased, Money not only increased its rates, but in order to get more business it increased its limit to 50% of pay, in line with most of the competitors. Someone who can‟t manage to meet bills right now from his or her pay is very unlikely to be able to give up 50% plus fees of the next pay. These high lending limits create debt traps and make the borrowers dependent. If this were simply an occasional service, we would see borrowers coming only very infrequently. Ernst & Young (2004) find that the ratio of repeat to new customers is 15:1, and that is consistent across all sizes of payday lending firms.
Legal Domain. Schwartz and Carroll (2003) define their legal category of CSR as follows: “[The legal domain]…pertains to the business firm‟s responsiveness to legal expectations mandated by and expected by society in the form of federal, state, and local jurisdictions, or through legal principles as developed in case law… compliance [with the law] can be further sub-divided into three types: passive, restrictive, and opportunistic. The first type of compliance is of a passive or accidental nature - the company is doing what it wants and just happens to be complying with the law…The second type of compliance, referred to as restrictive compliance, occurs when a corporation is legally compelled to do something that it would not otherwise want to do…The third type of compliance is that of opportunistic compliance. There are two general modes of opportunistic compliance. First, a corporation may actively seek out and take advantage of loopholes in the legislation to be able to engage in certain activities. In such cases one typically finds that the corporation is abiding by the letter of the law but not the spirit of the law. Second, a corporation may choose to operate in a jurisdiction because of its weaker legal standards. In such a case, the corporation has based its decision on the legal system, and is still technically complying with the law...Activities would fall outside of the legal domain when they take place despite: (i) an awareness of non-compliance with the law; (ii) an awareness of actual or potential civil negligence; or (iii) merely passive compliance with the law.” Assessment: In terms of the pay day loan industry, although in many respects one might argue that its actions fall within the legal domain, the industry also in some jurisdictions appears to clearly fall outside of the legal domain. Most jurisdictions have legislation prohibiting charging interest per year over a certain percentage, and the firms presumably are well aware of this fact.
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The two firms together have over 50% of the payday loan market and no other firm has more than 5%.
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In Canada for example, the maximum level of interest to be charged is 60% per year, based on section 347 of the Criminal Code, which was enacted in 1980. The largest payday loan companies try to appear to be in technical compliance with the law by charging additional fees that are not specifically labeled as interest payments, yet they clearly are part of the cost of borrowing. A simple reading of s. 347 supports the notion that all fees charged to a borrower are considered part of interest for the 60% limit. The Attorneys-General of the provinces have not been granting permission to prosecute under the Criminal Code. We do not have any public statement explaining why. One possibility is that the governments recognize that there is a legitimate need for such small loans, and are reluctant to use the big club of criminal prosecution, which would certainly close down payday lending altogether. The industry could thus argue that since usury laws are not being enforced, it is legally acceptable to charge excessive rates. Class action lawsuits launched in Canada have been vigorously defended by payday loan firms. Some firms in Canada have engaged in opportunistic compliance. One firm charged 59% interest and then added a large “insurance” fee, which it claimed was not interest. This case disappeared when the insurance regulators ordered it to stop calling it insurance, since it had no insurance licence. Cash Store, the second largest Canadian firm, charges 26% (formerly 22.5%) to broker the loan to a lender. The lender then charges 60% or less in interest. This arrangement has not been tested in court, but even if it manages to clear a strict legal hurdle, it is still clearly a very high cost for the borrower. Some firms in the U.S. appear to engage in opportunistic compliance. For example, Advance America, Cash Advance Centers, Inc., is the U.S. leading payday lender in terms of number of stores. Apparently the firm “…allied with out-of-state bank in 2002 to evade limits that some states imposed on the industry‟s excesses.” (Karger, 2005, p. 7). Other firms may be attempting to engage in opportunistic compliance by using innovative ways of charging additional fees, and not calling such fees interest. The legal situation does appear to now be in the process of changing in Canada. The Canadian Federal government is proposing legislation to allow it to evade responsibility for the payday loan industry by removing the interest limit in the Criminal Code. Several provinces, such as Manitoba and Saskatchewan, are beginning to regulate payday loan terms, but they have not specified any limits on fees charged. Ethical Domain. According to Schwartz and Carroll (2003), the ethical domain of the three domain model refers to the ethical responsibilities of business as expected by the general population and relevant stakeholders, and includes three general ethical standards: (a) conventional; (b) consequentialist; and (c) deontological. (a) Conventional standard: For the purposes of their model, Schwartz and Carroll (2003), define the standard of conventions as “…those standards or norms which have been accepted by the organization, the industry, the profession, or society as necessary for the proper functioning of business.” They indicate that “…reference should be made to formal codes of conduct or ethics (e.g., organizational, industrial, professional, or
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international) to establish whether a company is acting ethically according to the conventional standard.” Assessment: There is evidence both for and against the industry claim that it is acting in accordance with a conventional standard. The current set of industry standards (e.g., industry codes of conduct) do not limit the amount of interest and fees that payday lenders may charge. On the other hand, these codes do prohibit some socially undesirable practices. Society does not appear at this point to have raised any major objection to the practices taking place, and the significant number of users of pay day loan services suggests that the service is considered to be not only morally acceptable but highly desirable, if not necessary. Two North American codes of ethics or conduct appear to be followed. The U.S. Financial Service Centers of America (FiSCA) has a Code of Conduct, while the Canadian Payday Loan Association (CPLA) has developed a Code of Best Business Practices for its members. While both codes have provisions which if lived up to would address many ethical concerns (e.g., integrity, disclosure, rollovers2, confidentiality, etc.), the primary ethical issue they do not address is the current rate of interest being charged. (b) Consequentialist standard: According to Schwartz and Carroll (2003), the consequentialist standard “…focuses on ends or consequences” and “…suggests that “…the morally right thing to do is to promote the good of persons” An action is considered ethical according to consequentialism “…when it promotes the good of society, or more specifically, when the action is intended to produce the greatest net benefit (or lowest net cost) to society when compared to all of the other alternatives.” Assessment: The application of this standard to the payday loan industry highlights some of the more difficult aspects of the ethical analysis. The benefits of the industry to society can be identified in terms of the number of users of the service, and the short term alleviation of hardship that easier and quicker access to funds that can take place. Many customers would potentially not be able to obtain short term credit but for the payday loan industry. Howard Karger, in his book Shortchanged: Life and Debt in the Fringe Economy (2005) summarizes the situation for many people using the payday loan industry. According to Karger‟s research (2005, p.4), people simply “can‟t wait for checks to clear” and “live hand-to mouth” meaning that “…waiting a week or more for a check to clear the banking system means not having food on the table.” In other cases, many people live in “a cash economy, and many of the small shops where they buy food, clothing, and other necessities accept only cash. Checks are viewed sceptically and generally not accepted.” Many people do not trust banks, and don‟t feel welcome there. Others are also “…reluctant to write checks for fear of bounced-check fees from banks and merchants.” Those working in the industry itself certainly benefit, including
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A rollover occurs when the borrower cannot repay the loan on the due date, and the lender converts it to a new loan due on the next payday, but also charges all the fees as if it were a new loan. Recall that the fees are mostly fixed dollar and fixed percentage of the principal. A rollover thus creates a loan that is compounding at a phenomenal rate, trapping the debtor.
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shareholders/owners, employees, and suppliers. Governments (and thereby society) also derive the benefit of the tax revenue that is generated from the industry as well. An important part of this consequentialist analysis involves other participants in the financial services sector. The problems caused by lack of access to financial services for the poorer segments of society are a source of constant debate between free market advocates and welfare state supporters. Particularly in the US, the ability of banks to abandon markets that are not profitable enough is widely-supported.3 This problem is less prevalent in Canada, but even so, the banks do not provide the same ease of service in poorer neighbourhoods. ACORN4 Canada (2004) uses overlay maps and wealth measurements of postal codes to show that the major Canadian banks (six of them control the great majority of all banking in Canada) have generally closed branches in poorer neighbourhoods during the period 2001 – 03 (700 branches were closed during this period alone). This point was brought home graphically when ACORN released Robinson (2006) in a press conference held on the sidewalk in front of a Money Mart store in May 2006. ACORN did not itself recognize the symbolic significance of the specific store chosen – it was housed in a former stand-alone bank branch building that one of the big six Canadian banks had closed after decades on the site. Furthermore, there was not a single branch of any of the mainstream financial services companies within eyesight, even though the neighbourhood is reasonably densely populated and the street is one of Toronto‟s busiest commercial thoroughfares. Of course, the neighbourhood is lower income. So we could argue that the banks (and in Canada this also includes some smaller players called credit unions, caisses populaires and trust companies) are in fact the unethical players because they have exited markets that needed them. The payday lenders are the saviours by becoming the financial services providers in these markets, and also doing it a lot more nicely and at later hours than the banks.5 The difficulty in the analysis arises with respect to calculating the potential long-term hardship that may occur. While users of the payday loan service clearly derive a short term benefit, it is not at all clear whether they are digging themselves into some sort of debt trap, which due to the onerous interest charges, only generates long-term hardship. One way to assess the difficult trade-off is to use the traditional regulatory analytical model to estimate whether an industry is earning excess profits. Robinson (2006) find the payday lending industry is earning excess profits. The analysis rests on the
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Note that we are not talking about the very poorest members of society with respect to payday loans. To get a payday loan a person needs a job and a bank account, which means also a relatively fixed home address. 4 Association of Community Organizations for Reform Now. An anti-poverty self-help community coalition builder started in the US, but now with similar groups in other countries like Canada. 5 Most payday lenders offer more than just loans. The two major lines of business are payday lending and cheque cashing, but other services may include secure international money transfers, currency exchange and tax return preparation and refund discounting.
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assumption that we should not want to continue to allow terribly inefficient firms to continue to operate by allowing them to charge higher fees than the efficient producers could manage. The level of fees that Robinson recommends as a limit for payday lending is dramatically lower than the current fees6, but still very high – effective annual rates are mostly greater than 1,000% p.a. Robinson (2006) argues that the payday lending industry is very inefficient. It is quite small compared with even the smallest of the mainstream financial institutions. Its large fees are due to the exorbitant rates, rather than to a large volume of business. A typical payday store might make only 20 – 30 loans per day, which is a loan volume of only $7 $11,000 per day. At such small business volumes, the fixed cost of the premises and the need for staff on duty at all times forces a payday lender to charge very high rates. While an overall assessment of the net benefit to society is therefore problematic, one can make the case that if the long-term is taken into account, the industry is not generating a net benefit to society, and would need to reduce interest rates before this would more clearly take place. One question to ask however is would society be better off if the industry ceased to exist? Would it be better if an even bigger underground lending industry (e.g., mafia) began to flourish, also charging excessive rates, being completely unregulated, and with no tax revenue going into the government‟s coffers? Would more severe repercussions take place for those customers failing to pay their debts? In response, some would suggest however that even the mafia would never charge interest rates comparable to those charged by the payday loan industry. One Canadian politician stated that the payday loan industry is worse than loan sharks, and “charge interest rages that would make Tony Soprano blush” (Rupert, Ottawa Citizen, date?, p. E5). This component of the analysis (e.g., payday loan industry versus other alternatives) suggests that it may be better if the industry continues to exist, but only if modified (e.g., payment terms more restricted and enforced) would lead to the overall greatest net good for society. (c) Deontological standard: The deontological standard, as opposed to focusing on consequences, is according to Schwartz and Carroll (2003) defined as embodying those activities which reflect a consideration of one‟s duty or obligation. This category embraces moral rights, justice, religious doctrine, Kant‟s categorical imperative and core values such as trustworthiness (i.e., honesty, integrity, reliability, loyalty); responsibility (i.e., accountability); caring (i.e., avoid unnecessary harm); and citizenship (i.e., assist the community, protect the environment). According to Schwartz and Carroll (2003), activities would fall outside of the ethical domain when they are: “(i) amoral in nature (i.e., with an unawareness or indifference to the morality of the action); (ii) take place despite an awareness that the action conflicts with certain moral principles (i.e., are unethical); or (iii) are only intended to produce a net benefit for the corporation and not for the affected stakeholders (i.e., are only
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The report estimates annual saving to consumers of $194 million just from lowering the fees to the recommended limits.
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supported by egoism).” Assessment: There appear to be many deontological concerns with respect to the activities of the payday loan industry. Kant/Exploitation: The payday loan industry may be seen as exploiting a vulnerable population. In particular, any firms that engage in any “rollover” practices, or use threats and phone calls to employers of delinquent debtors, may be seen as taking advantage of the misfortune of certain members of society. Justice/Fairness: There also seems to be an unequal relationship of power and knowledge (e.g., ignorance and lack of informed consent) of the providers relative to their customers, leading to an unfair advantage in the transactions that take place. Most of the customers are the working poor, who don‟t realize how expensive the transactions really are. In response, the industry can argue that the rates they charge are fair, as customers clearly need the product and are willing to pay the fees. It is up to the client to exercise self-control, not the industry. The branches are often open during more convenient hours than banks, in better locations. In addition, the unequal relationship may be balanced with the risks taken by the industry with respect to bad debts, supporting the fairness of the excessive rates being charged. Transparency/Rights: There are also a number of issues with respect to the extent to which transparency, disclosure, and honesty is taking place within the industry. Without full knowledge, customers may in fact not be giving fully informed consent to the transaction. Customers clearly have the right to full information and disclosure. In response, the industry could argue that it is not at all clear whether the use of the service would discontinue if the rates of total interest being charged were more fully and clearly disclosed. Certainly new users of cigarettes are now fully informed of the health risks, yet they begin to smoke being aware of the risks (as opposed to current smokers who might be physically addicted to the use of the product). Conclusion We conclude based on our analysis that the industry is at present a perfect example of what Schwartz and Carroll (2003) label the “purely economic” firm or industry, as it appears to focus only on maximizing profit and shareholder value while clearly falling outside of the legal and ethical domains in each and every respect. As a response to this assessment, we propose a new “Code of Ethics and Social Responsibility” for the entire industry. If the industry was to in fact abide by this code, then it could be argued as falling with both the economic and ethical domains (see Figure 1). As it is not expected for the industry to begin to comply with current legislation, if laws are changed and fully complied with, then the industry would also fall within the legal domain. Future research should take place to more fully examine the societal implications of this important new money lending industry. References (Partial)
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Acorn Canada (November 2004). Protecting Canadians’ Interest. Reining in the Payday Lending Industry. http://acorn.org/fileadmin/International/Canada/Reports/Payday_Lending_Report.pdf Ernst & Young (October 2004). The Cost of Providing Payday Loans in Canada. http://www.cacfs.com/english/measuring_en.htm. Karger, H. (2005). Shortchanged: Life and Debt in the Fringe Economy. San Francisco: Berrett-Koehler. Lewison, M. (1999). Conflicts of Interest? The Ethics of Usury. Journal of Business Ethics 22(4): 327-339. Robinson, Chris (May 2006). Regulation of Payday Lending in Canada. To be placed on the same website as ACORN Canada (November 2004). Rupert, Jake, Looking For a Real Life Ottawa Loan Shark, The Ottawa Citizen, December 3, 2005 E5. Schwartz, M.S. and Carroll, A.B. (2003). “Corporate Social Responsibility: A Three Domain Approach,” Business Ethics Quarterly, 13(4): 503-530.
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FIGURE 1
The Three Domain Model of Corporate Social Responsibility and the Payday Loan Industry
(iii) Purely Ethical (iv) Economic/ Ethical (vii) Economic/ Legal/Ethical (i) Purely Economic (v) Economic/ Legal (ii) Purely Legal (vi) Legal/ Ethical
Payday Loan Industry (current)
Payday Loan Industry (abiding by law and proposed code of ethics)
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