By Ylan Q. Mui
Washington Post Staff Writer
Tuesday, October 13, 2009
For years, the country's makeshift network of payday lenders and check cashers has operated with little competition or federal regulation.
But as the financial crisis sparks a new wave of consumer protections, lawmakers and the private sector alike are training their sights on an industry that caters to the most vulnerable of populations: the estimated 40 million households on the margins of the nation's financial system, with limited, if any, access to banks or credit.
Congress is debating the creation of a Consumer Financial Protection Agency that would provide federal oversight of the industry for the first time. In addition, several bills have been introduced to cap the often-triple-digit interest rates on payday loans, long considered by many one of the industry's most abusive practices.
Meanwhile, big companies are muscling into a sector that has been dominated by independent operators, lured by the promise of a largely untapped $13 billion market. Wal-Mart, the world's largest retailer, stepped up the competition earlier this year by slashing prices on its most popular financial services, such as check cashing. Start-ups have emerged to offer lending to niche groups, such as Hispanic immigrants, at dramatically lower rates.
"People are always damaged by these products. . . . This can be the thing that pushes them over the brink," said Rachel Schneider, innovation director of the nonprofit Center for Financial Services Innovation. "In a recessionary environment, the consequences of using predatory products are more apparent."
In the financial world, those without access to traditional financial services have been dubbed the "unbanked." With spotty bank records and thin or nonexistent credit reports -- documents often required to rent an apartment, buy a cellphone or even get a job -- they rely on storefront businesses that may charge a 4 percent fee to cash a check or a 995 percent annual interest rate for a short-term loan.
Though the number of unbanked is difficult to track, Schneider said anecdotal evidence suggests that their ranks increased as the recession deepened. The center estimates that median household income for the unbanked is $26,390 -- about half of the national median -- and many have little to no savings.
Anthony Jeffers lives in North Carolina, where the unemployment rate is 10.7 percent, and he travels to Washington every other month to hunt for construction work. The costs are high -- he pays for an apartment in both places.
The expenses overwhelmed him last year, so Jeffers turned to a payday lender to get $800 for his rent. When he repaid the loan two weeks later, he owed about $1,100, meaning he paid more than 30 percent interest, or 975 percent on an annualized basis.
"All you're thinking of is getting your money to take care of your situation," said Jeffers, who was standing outside a check casher in the District on a recent afternoon after buying a money order to pay his rent back home. "It just seems like a lot of interest to pay back."
The proposed federal agency -- one of the White House's signature pieces of legislation -- would have broad authority to set new national standards for the non-bank industry and investigate complaints, marking the first time the industry would fall under the eye of a federal agency. Until now, it has been overseen largely by the states. Congress is still hashing out details of the legislation, and a vote is expected this fall.
"We want a watchdog on the financial industry, both the currently regulated and the unregulated market," said Steve Adamske, spokesman for the House Financial Services Committee. "Hopefully, this agency will level the playing field."
Three bills in the House and one in the Senate that were submitted this spring seek to curb one of the industry's most controversial practices: charging triple-digit interest rates for short-term loans to risky customers. The bills would impose caps as low as $15 for every $100 borrowed and, in some cases, require greater transparency of the lending terms.
But industry representatives say they provide necessary services for households that have become alienated from traditional financial institutions. Many of their customers have poor credit and may not qualify for basic bank accounts. The payday-lending industry has opposed capping interest rates, and its trade group, the Community Financial Services Association, is raising $1 million from its members to lobby against the bills. CFSA spokesman Steven Schlein said the group has reserved judgment on the proposed Consumer Financial Protection Agency.
"It's all in the details," he said. "It would be a big change for us."
The Financial Service Centers of America, which represents check cashers, said that it supports increasing transparency to customers but that additional federal regulation "is unnecessary and duplicative and will only increase the cost of financial services to consumers without any corresponding benefit." The trade group for payday lenders said it began requiring members to display their fees on posters in their stores last year.
Industry advocates argue that innovation -- not legislation -- is the key to reform. And the private sector has been quick to step in with other solutions.
Some credit unions offer short-term loans as an alternative to payday lenders. North Side Community Federal Credit Union in Chicago, manager Ed Jacob said, introduced a six-month, $500 loan with 16.5 percent interest several years ago. The credit union has since made 5,000 such loans, and it has become one of the most popular products.
Meanwhile, start-ups such as Progreso Financiero in California are targeting new niches. James Gutierrez founded Progreso in 2005 to make short-term unsecured loans of $250 to $2,500 to Hispanic families lacking credit scores and banking records. The company charges 36 percent interest, significantly less than other payday lenders charge but still more than double the average consumer credit card interest rate.
Financiero has made about 25,000 loans to its customers in California but needs to make 100,000 before it can turn a profit because the loan amounts are so small and the cost of doing business is high, Gutierrez said. Jacob said the credit union doesn't make any profit from its payday-loan alternatives. Instead, it hopes to boost members into good financial standing so they can then apply for profitable products such as auto loans.
Some industry veterans are also moving into the sector. Just this year, Wal-Mart lowered the price of its prepaid debit card to $3 and its fee to cash checks to a maximum of $3. It also allows shoppers to pay many of their bills in stores. The giant retailer estimates that about 20 percent of its customers are unbanked.
"Our customers are living paycheck to paycheck and watching every penny," said Jane Thompson, director of Wal-Mart's financial services.
But perhaps the biggest hurdle the industry faces is improving customers' financial literacy. Many are afraid of leaving their money in banks, do not have the documentation to open a bank account or have had accounts closed. They also may not understand how loans are structured.
D.C. resident Gregory Warf, 20, said he doesn't want a bank account. He turns his savings over to people he trusts, like his brother, or hides it. If he needs to cash a check, he goes to the nearest liquor store, which charges him a fee. And if he needs money -- say, $10 to put on his SmarTrip card -- he asks a friend.
"I'd rather have my money in my possession," Warf said. "I don't really trust anybody else."