Payday Lending and Overdraft Protection

I’ve noted previously, I have a forthcoming paper with former Comptroller of the Currency Robert Clarke that examines competition between payday lending and bank overdraft protection. The central point is easy to grasp–payday lending and overdraft protection are products offered by different providers but which compete for the same customers. And evidence indicates that in choosing between the two products consumers generally choose rationally.

The point came to mind (yet again) reading the Wall Street Journal yesterday, “Hefty Bank Fees Waylay Solders.” According to the article, many members of the military are frequent users of bank overdraft protection, which has caused some concern in some quarters. The article provides no hard evidence that usage of overdraft protection has risen in recent years, but implies that the general impression is that it has.

Assuming that the perception is correct that usage of overdraft protection by military members has risen in recent years, why would that be?  Well, how about the enactment of the Military Lending Act in 2007, which imposed a 36% APR cap on payday loans to military members, effectively outlawing payday loans (and some other products for military members):

 Congress cracked down with the Military Lending Act, which, starting in 2007, limited to 36% the APR interest on many payday-style loans to military members.

Since then, overdraft programs have replaced payday lending as the leading financial problem for many military personnel, says Adm. Abbot of the Navy-Marine relief society. Some financial institutions serving the military have reined in overdraft fees, he says, while others are engaged in “predatory or punitive overdraft practices.”

Eliminating access to a particular product (payday loans) doesn’t eliminate the need for credit. It is entirely predictable that eliminating payday loans to service members will result in increased use of bank overdraft protection–just as it does for civilians.

Moreover, as we note in the article, in many situations payday loans are less expensive than overdraft protection (it appears from the article that the break even point in favor of overdraft protection is lower than for payday loans because overdraft fees on military bases are lower than typical market rates) and consumers understand this and use the products rationally. So the net impact of the MLA in some cases will be to take away a less expensive product and lead to greater use of a more-expensive product.

In the end, the article doesn’t report the data as to whether usage of overdraft protection rose after the MLA was enacted. But it would violate the predictions of economics if it didn’t.