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“Rationality and Regulation of Payday Loans”

“Rationality and Regulation of Payday Loans”. Paige Marta Skiba Associate Professor of Law September 2011. Regulation . Bans Interest rate caps Loan-size restrictions Military constraints Loan lengths Information disclosures. Imperfect Information in Subprime Credit .

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“Rationality and Regulation of Payday Loans”

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  1. “Rationality and Regulation of Payday Loans” Paige Marta Skiba Associate Professor of Law September 2011

  2. Regulation • Bans • Interest rate caps • Loan-size restrictions • Military constraints • Loan lengths • Information disclosures

  3. Imperfect Information in Subprime Credit • Information asymmetries are important in theory • e.g. Stiglitz and Weiss, 1981 • Ensuing credit market failures can create inefficiency at micro and macro level • Understanding causes liquidity constraints is important for policy responses

  4. Imperfect Information in Subprime Credit • Moral Hazard • Individual borrowers are more likely to default on larger loans • Borrowers do not internalize the default costs of larger loans • Adverse Selection • Risky borrowers want to borrow a lot because default likely

  5. Empirical Strategy • The largest recommended loan is a discontinuous function of customer income.  • Firms allow loans that are < ½ paycheck. • And, loans come in $50increments • Customers with very similar incomes receive different size loans

  6. Loan eligibility

  7. Empirical Strategy • Regressing default on loan amount captures both MH and AS • OLS coefficient on loan size includes • The causal effect of having a larger loan on the probability of default ( MH) • The correlation induced by observably equivalent borrowers taking out different loans (with private information about their own risks = AS) • To separately identify the effect of MH, we isolate exogenous variation in loan amount • IV instruments loan amount with eligibility indicators, identifying the effect of the loan size holding selection contact (MH)

  8. Regression Results

  9. Results • No moral hazard • $100 larger loan decreases probability of default by 4 percentage points • Adverse section • Choosing a $100 larger loan increases probability of default by 8 percentage points • Strong evidence of liquidity constraints • An additional $1 of credit available • Borrow 50 cents • This is huge compared to literature

  10. Regulation • Bans • Interest rate caps • Loan-size restrictions • Military constraints • Loan lengths • Information disclosures

  11. Regulation • Bans • Interest rate caps • Loan-size restrictions • Military constraints • Loan lengths • Information disclosures

  12. Army Personnel are more Likely to Default When controlling for loan length, credit score, loan size, pay frequency, and state, probability of renew and default and statistically significantly different.

  13. Reflections on effectiveness of payday lending constraints • Bans • Misguided • Interest rate caps • Essentially banning • Loan-size restrictions • Larger loan better? • Military-specific rules • ? • Loan lengths • Longer or shorter loans doesn’t matter • Information disclosures • Useless if care about rollovers

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