A Rose By Any Other Name?

I have never understood why the idea of usury was never applied to credit card APR's, overdraft fees and my favourite, "pay-day" loans.

There had been a Banking Regulation in the United States, Reg Q, that limited the interest rate banks could pay on savings deposits. In a twisted logic this regulation was intended to stop loan-sharking. I will admit, I never understood the connection except in an inverse relationship.

Somehow, a limit on the interest that could be paid on deposits was intended to limit that which could be charged on loans. Of course in a regulated banking system a maximum spread between deposit and loan rates could be set. But how that would have any impact on an unregulated and illegal loan-sharking world is beyond me.

What appears to have happened is that the banks, especially over the last couple of years in response to revenue losses resulting from the financial crisis and the introduction of new regulations have started to move into the loan-sharking space.

Yes, this might strike many as somewhat of an exaggeration. The common image of the loan shark is someone who lends you $10,000 today and demands to be paid $20,000 in two weeks. And yes, there is usually the added incentive of the threat of violence in the event of non-payment.

Now look at payday loans which initially were licensed by "non-standard" lenders. In the name of free market capitalism these lenders were allowed to provide loans to those that didn't qualify for standard loans from banks. In a 2001 report comparing short-term "payday" loans it was found that the rates charged by legal non-standard lenders in California were often considerably higher than the interest rates charged by Chicago crime syndicates for the same loan.

Fast forward to the present. The Franks-Dodd Regulation has instituted limitations on first-year credit card fees and on late fees and restrictions on APR increases as well as the outright prohibition of overdraft fees without opt-in. It was found that some banks charged as much as $300 a day for the use of an overdraft facility on top of the interest charged.

The first response by many banks was to unilaterally raise their APR's, despite the fact that losses and their costs of funding-look to see what your bank deposits earn-have come down. As the banks come under more political and regulatory pressure the terms for APR's will presumably start to decrease on their standard products. The response of the banks has been to go down the credit curve in their search for more profitable areas to exploit.

Banks that claim they could never offer a sub prime credit card with a 30% APR have felt no qualms in moving into the lucrative unsecured loans market that is virtually indistinguishable from the payday loan market, except that they are marketed as "deposit advance loans". They are offered to customers with checking accounts, which is intended to demonstrate that they are not shady loan providers operating in a non-regulated area with shoddy documentation. Now they are above board in charging APR's of 200% and more.

They go further however. To avoid being accused of usury, they don't charge interest rates, but rather flat fees. These too, like the term "deposit advance" loans are another example of changing the name but not the activity. The effective annualized compound interest rate is easily in the triple-digit range.


The only positive in all of this is somewhat ironic. By moving into the "payday" space banks are gathering in people who had no access to bank credit. Despite the fact that the rates charged are exorbitant, they are not accompanied by insinuation or even overt threats of physical violence. It is interesting to see what was an illegal activity be brought into the mainstream, despite the predatory aspects of the activity.

It leaves me in this holiday season wondering what other illegal activities would benefit from being brought into a legal, regulated framework...

Seasons Greetings!