Disrupting the Payday Lending Industry
In Canada, there are over 1,300 payday lending outlets that provide extremely expensive but quick and effective ways to borrow short-term money. Payday lenders charge between $15–25 in fees per $100 borrowed for two weeks, resulting in annual percentage rates of upwards of 500 percent. In contrast, Canadian law prohibits other lenders from charging more than 60 percent annual interest on loans.
Despite the high cost of borrowing, the use of payday lenders continues to increase. From 2009 to 2014 (latest available numbers), the number of Canadian adults that reported using a payday loan increased from two percent of households to four percent, borrowing nearly $2.2 bn worth of loans in 2014. Consumers typically use payday lenders as a short-term fix when they’re in need of cash to pay an upcoming bill or an unexpected expense. However, because of the high fees, many become stuck in a cycle of debt. According to the Financial Consumer Agency of Canada, more than half of payday-loan customers used the service at least twice in a three-year span. One quarter of payday loan customers used it six or more times.
As a result, municipal and provincial governments across Canada are increasingly regulating the payday lending business by restricting the number of payday lenders within a certain jurisdiction, capping what payday lenders can charge, and extending the payback period on these loans.
While these laws may severely restrict the industry itself, they do not address the true issue behind the growth in payday lending — the increasing demand for short-term credit and the lack of affordable options in Canada. As a result, these regulations run the risk of forcing consumers to find other, even more expensive options for cash such as unregulated online lenders, pawn shops, and loan sharks.
Instead of focusing on regulations, there should be increased focus on supporting the scaling of innovations that can disrupt the payday lending business. By considering the journey of a payday lending customer, we can then design, develop, and scale solutions that target each step of this journey.
For example, let’s consider why there’s a need for short-term lending in the first place. In many cases, it’s a result of a combination of unexpected expenses, income volatility, and cash flow problems. What if there were innovative solutions that addressed these issues in the first place?
Even, a venture out of the Center for Financial Services Innovation’s Financial Solutions Lab, offers an interesting solution to help individuals deal with cash flow. They offer a solution called Instapay that allows employees to collect wages ahead of scheduled paychecks when unexpected expenses occur. Instead of resorting to a loan, employees are better equipped to deal with these unexpected expenses with their own money. Recently, Walmart has announced a partnership with Even where all of their US associates can request instant payments up to 8 times a year.
Even, a venture out of the Center for Financial Services Innovation’s Financial Solutions Lab, offers an interesting solution to help individuals deal with cash flow. They offer a solution called Instapay that allows employees to collect wages ahead of scheduled paychecks when unexpected expenses occur. Instead of resorting to a loan, employees are better equipped to deal with these unexpected expenses with their own money. Even is used by over 200,000 employees and recently raised $40 million.
Another reason why individuals borrow from Payday Lenders is because they feel like there are no available alternatives to them. Payday lenders are approachable, easy-to-understand, and more flexible than loans from banks. What if we can provide these same benefits to borrowers but at a much cheaper rate?
Credit unions such as Vancity, Websters Five Cents Savings Bank, and the Windsor Family Credit Union are doing just that. In 2014, Vancity introduced their Fair & Fast Loan product which offers up to $2,500 in as little as 10 minutes at an annual percentage rate of 19 percent. Any individual can apply for the loan at any Vancity branch while Vancity members can borrow directly online. By doing so, Vancity offers the same level of service and convenience that Payday Lenders offer but at significantly cheaper rates.
We can also consider whether there are better ways to assess risk than a credit score. The use of credit scores can be incredibly limiting for certain Canadians, such as newcomers. With the wealth of data that we have on consumers these days, are there not better ways to assess and predict risk?
For example, Tala, a startup that currently operates in Kenya, uses mobile data points such as network diversity, social connected-ness, geographic patterns, and financial transactions to assess customers for loans. Additionally, as users borrow and payback their loans through Tala, they are able to build their credit history so they can eventually migrate to the traditional financial services system.
Saida, also in Kenya, uses information on how borrowers manage their prepaid cellphone plan while Destacame in Chile uses bill payments to assess credit.
Finally, while the solutions that we’ve outlined above are methods to reduce the usage of payday lenders, the reality is that there are millions of Canadians that have borrowed from payday lenders already and are stuck in a cycle of debt.
The Causeway Community Finance Fund, out of Ottawa, has created an innovative community-led initiative that addresses this problem. It provides individuals that have already borrowed from payday lenders with $500 — $1500 low-interest loans. With each prospective borrower, Causeway also works through 6-month of bank statements and helps them form a detailed budget. By doing so, they are ensuring that each borrower has the capacity to repay their loans, helping individuals get out of the payday lending trap.
The reality is that across Canada and globally, innovative solutions that can improve the financial health of millions of Canadians already exist. Using regulation to restrict payday lenders and how they operate today only does so much. What we really need is an enabling environment that helps these innovative solutions get started, tested, scaled across Canada so that it can help improve the financial health of millions of Canadians.
Creating this enabling environment is exactly what we want to do at Innovate Financial Health. If you are interested in learning more, please feel free to comment below or reach out to me at elvis.wong@innovatefh.com to chat.
This article was originally published on LinkedIn.
