There is no shortage of media coverage about the global financial crisis, bank bailouts, bankers’ bonuses, fears of double dips, and the like. But there is another financial crisis occurring on the streets of every Canadian city: the spread of the cheque-cashing and payday loan industry. The growth of these fringe financial institutions illustrates a collective failure of the financial system in Canada to adequately address the basic financial needs of low-income Canadians.
Governments have regulated the payday loan industry, but have done so in ways that do more to protect the industries’ profits than the consumer. Mainstream banks and credit unions are losing their own low-income clients to the fringe institutions because their relationships with these clients are breaking down. And the payday loan industry itself continues to charge exorbitant rates of interest. All of which leaves a local financial crisis: low-income people paying fees they can ill afford to either cash a cheque or get a small loan for a short period of time.
Government regulatory failure
Fringe financial institutions (FFIs) have until very recently operated within a generally unregulated environment since they are not deposit-taking institutions and hence have fallen outside of the regulations placed on the mainstream financial sector. There have been some elements of self-regulation, managed under the auspices of the Canadian Payday Lenders’ Association (CPLA) and, at the federal level, Section 347 of the Criminal Code, passed in 1980, set the maximum legal rate of interest for loans at 60% per annum -- a figure which explicitly includes the various fees that are often charged by the FFIs as disguised interest charges.
Even though this regulation had virtually no enforcement mechanism, amendments were later passed to allow provinces to impose their own regulations and thereby override Section 347. Many provincial governments have since opted for a regulatory approach that accepts the growth of FFIs as better than having people turn to informal loan sharks. Provincial regulations typically require FFIs to be licensed, and regulations are placed on the types of loans that can be provided (so that rollover loans, for example, are not permitted), as well as the amount of information that must be provided to borrowers.
This provincial regulatory option also allows provinces to set fee levels. For example, in November 2009, the B.C. government introduced legislation which includes the regulation of maximum charges. All payday lenders in B.C. are now restricted to charging a maximum of “23% of the amount borrowed in interest and fees” on loans of up to $1,500 that are short-term (defined as any loan period up to 62 days). This allows for annual interest payments vastly in excess of the federal Criminal Code provisions and, in fact, does more to protect the profits of the industry and decriminalize usury than to protect the consumer.
Given that the average payday loan in Canada is $280 for a 10-day period, a payday lender in B.C. can now legally charge $64.40 for this transaction. This computes to a nominal annual percentage rate of interest (APR) of 839.5 %. As a point of reference, the Bank of Canada’s bank rate is currently 1%, and a typical credit card carries a 19.5% APR.
Introducing provincial legislation to replace the provisions of the Criminal Code has proven popular across Canada. Provinces adopting this approach, in addition to B.C., are Alberta, Saskatchewan, Manitoba, Ontario, New Brunswick, and Nova Scotia, with legislation also under discussion in Prince Edward Island. All provinces with legislation require payday lenders to be registered with the province, and all set maximum charges. Nova Scotia maintains the federal legal maximum of a 60% annual interest rate, but then permits the addition of various “fees” up to a cap of fees-plus-interest of $31 per $100 of loans. Other provinces just set a limit on total charges per $100 loan without specifying what the interest component must be; this total ranges from $17 in Manitoba to $21 in Ontario and $23 in both B.C. and Alberta. So provincial regulation looks more like industry cost-and-profit protection than consumer protection.
We have reached the situation where middle-income earners can borrow hundreds of thousands of dollars on a five-year mortgage at 4%, while low-income earners face borrowing a few hundred dollars for a couple of weeks at 800%!
Mainstream Bank and Credit Union failures
The term financial exclusion usually refers to those who are outside of the mainstream financial system, and the term “unbanked” is typically used to describe the financial status of people in this situation. In Canada, this is estimated to be anywhere from 3% to 15% of the adult population, and it is this unbanked population which is usually thought to be the main client base of the FFIs.
Our survey results from Prince George, B.C., paint a rather different picture. We interviewed 176 clients of FFIs between September 2009 and April 2010. The clients were typical in many respects to FFI users identified in other surveys: they had low incomes, low assets, were mainly in rented accommodation, and were predominantly male.
We also found in the Prince George survey that Aboriginal individuals are major users of FFIs, and 60% of our sample self-identified as being Aboriginal. Aboriginal users of FFIs had lower incomes, less education, were more likely to be younger, more likely to be unemployed, and more likely to rely on income assistance than the non-Aboriginal users. Thus, while the entire sample is a relatively low-income group, within that group it appears that the Aboriginal FFI users are even less financially secure.
We asked respondents about their experience and usage of mainstream financial institutions. Surprisingly, only 12% of the FFI users were unbanked in the sense of never having had a bank account. In contrast, 88% of FFI users in our sample had held a bank or credit union account at some point. The conclusion that the majority of FFI clients had experience with mainstream financial institutions was true for both Aboriginal and non-Aboriginal groups in our sample. Part of the explanation for this may be because, for payday loans, one of the main services provided by FFIs, clients are required by the FFI to have a bank account, although this not the case for their cheque cashing service. Even so, we wished to know how well-linked FFI clients were with their bank or credit union, and so we also asked interviewees if they currently used a bank or credit account regularly.
Half of them still regularly used such accounts. While 50% of our sample of FFI users could be described as unbanked in the sense that they did not currently use a bank or credit union account on a regular basis, the other 50% were clearly banked in an important sense and were, in fact, simultaneously dual users of both mainstream and fringe financial institutions.
This suggests that, among FFI users, there is a significant degree of experience with the mainstream financial sector, a contrast to our usual notions of “financial exclusion.” When asked why they preferred using FFIs, convenience reasons (both hours and location), as well as the ability to get cheques cased and loans approved immediately, were given as answers -- just as other surveys have found.
But there was also a significant number of responses which indicated that there had been a breakdown in the relationship between mainstream financial institutions and their clients, as the latter have fallen into financial difficulties which pushed them to using FFIs. This group has not been adequately recognized and might best be termed the “precariously banked.” They are regular users of mainstream financial institutions, but their relationship with that institution is precarious and, when they run into financial difficulties, they turn to the simultaneous use of FFIs.
When the creditworthiness of the precariously banked is adversely affected, they may find it difficult to obtain further credit from their banks or credit unions, so they turn to FFIs who advertise that they “approve all” applicants, albeit at high costs. For individuals with bad credit records, however, this is likely to be a short-term solution only, as the repayment conditions of the FFIs will quickly become just as (or even more) onerous than those of the banks and credit unions. Furthermore, as FFI users default on their payments to the FFIs, they incur NSF charges from the banks on which they have written cheques to the FFIs. FFI users therefore incur a “double whammy” of high FFI fees and bank NSF charges on a single payday loan.
The precariously banked typically have credit positions such that they can easily run out of financing options at their mainstream institutions and therefore resort to FFIs. This is an area where innovative mainstream institutions might experiment with how best to maintain their client base and provide small loans and credit counselling so that their clients can be assisted in times of financial stress.
It is clear that many low-income individuals are dual users, in the sense that they use both mainstream institutions and FFIs; the task that must be demanded of the former is that they find ways to innovate their services so that the need for this dual-track approach that so many take is reduced.
Some bright spots
Provincial governments seem largely satisfied that their regulatory approach is enough, but some efforts are being made to address the current failings of the financial system for low-income Canadians. For example, RBC has experimented with a Cash & Save concept in Toronto in an effort to provide more relevant services such as cheque cashing, bill payments, money orders, and wire transfers to low-income households at more reasonable rates than those charged by the fringe financial institutions.
Pigeon Park Savings (PPS) in Vancouver was opened in 2004 as a partnership between the Portland Hotel Society (PHS) and Vancouver City. PPS offers clients cheque-cashing, unlimited withdrawals, bill payments, money orders, and ATM access -- all for a simple fee of $5 per month, or will cash a cheque for a flat fee of $2.99. Currently, PPS is promoting financial literacy among its members and the community, in an effort to provide the “tools to make sound decisions” and to effectively deter the use of fringe financial institutions.
Further promotion of financial literacy services can be important and, in this respect, it is interesting to note that Manitoba, as part of its legislation regulating the industry, has required all FFIs in the province to pay an annual Financial Literacy Support Levy to the government to fund such programs.
In response to the findings of our report, done at the request of the Aboriginal Business Development Centre, new initiatives will be studied in Prince George with a view to providing a low-cost banking alternative for low-income residents in the city. It is clear that a response to the local financial crisis is needed in many of our communities.
(Paul Bowles is Professor of Economics at the University of Northern British Columbia; Keely Dempsey and Trevor Shaw are graduate students in the MA Development Economics and MA International Studies programs, respectively, at UNBC. For copies of the full report, please email [email protected])