Ontario Advisory Board Recommends $21 per $100

The Ontario Payday Loan Advisory Board issued its recommendations today and is calling for a rate cap of $21 per $100 in that province. The basis for its decision appears to be the result of an Ernst & Young study on the cost of providing payday loans in Ontario. The study concluded that the average weighted cost to provide a payday loan in Ontario was $21.50 per $100.

The E&Y study uses data from 9 of the more than 100 companies that provide payday loans in Ontario. To put this in perspective, the most representative cost study conducted to date was done by Deloitte in 2008. Deloitte looked at the cost of providing payday loans in British Columbia and surveyed 12 of the roughly 60 payday loan companies in that province. They found that the average cost of providing a payday loan in B.C. was $25.21 per $100.

The risk of using a cost study to determine the maximum allowable rate for a product in an industry with many participants is that if you settle on the average cost then you are still putting half of the industry out of business. Some have argued that lenders need only tighten their belts and all will be fine. Unfortunately it is not that simple.

First, business owners are likely our society's most efficient at tightening their belts. Those who have owned a business do not need to be told this, but for those who have not, you need only consider that every dollar an owner can save in efficiency improvement goes straight into his/her pocket. You will not meet a more motivated group when it comes to wanting to keep expenses at a minimum. I would argue that their belts are already tight.

Second, assuming that there are few notches left to tighten, where then does a payday lender cut costs? They could move to a cheaper location, shorten their hours, hire less skilled and lower paid staff. Each step leading to fewer customers and a less viable business, unless of course customers prefer poor locations, short hours and inexperienced staff. Not likely.

Finally, payday lenders could tighten their lending criteria and attempt to reduce their bad debt costs by being more picky about who they lend to. In E&Y's first payday loan study, The Cost of Providing Payday Loans in Canada, they identified a correlation between payday loan rates and bad debt risk, illustrating that the less a lender could charge the less risk they could assume.

In practical terms, a maximum allowable rate for payday loans that is based on the average cost to provide the product means that those companies who cannot tighten their belts enough (likely because they are already tight) will be out of business and those who can tighten will do so by restricting who they lend to. If consumer protection is the goal of this legislation then you have to look at where those consumers go and how protected they will be when their already limited credit options are restricted even further.

To steal from a previous post:

As the Policis study illustrates, some newly excluded borrowers may pay up to ten times the amount that they currently pay in order to borrow $100 from an illegal source of credit. Some will temporarily relinquish their personal assets in order to obtain a pawn loan and others will do without. Of the borrowers who do without, those who knew how to weigh the difference between the cost of a payday loan and the cost of bouncing a cheque will be worse off.

The best consumer protection is education and empowerment. Require consistent rate disclosure between all lenders so that consumers can easily identify the best option for them and their circumstances. Giving consumers fewer credit options in an already tight credit market does not get them any further ahead and I doubt it is what any of them are asking for.

The Ontario government has the final say on what the maximum allowable rate for a payday loan will be. I would encourage them to set a higher rate that will leave fewer people out of business and fewer borrowers out of options.