How payday lenders bounce back when states crack down

In state after state that has tried to ban payday and similar loans, the industry has found ways to continue to peddle them

A version of this story was co-published with the St. Louis Post-Dispatch.

In 2008, payday lenders suffered a major defeat when the Ohio legislature banned high-cost loans. That same year, they lost again when they dumped more than $20 million into an effort to roll back the law: The public voted against it by nearly two-to-one.

But five years later, hundreds of payday loan stores still operate in Ohio, charging annual rates that can approach 700 percent.

It’s just one example of the industry’s resilience. In state after state where lenders have confronted unwanted regulation, they have found ways to continue to deliver high-cost loans.

Sometimes, as in Ohio, lenders have exploited loopholes in the law. But more often, they have reacted to laws targeted at one type of high-cost loan by churning out other products that feature triple-digit annual rates.

To be sure, there are states that have successfully banned high-cost lenders. Today Arkansas is an island, surrounded by six other states where ads scream “Cash!” and high-cost lenders dot the strip malls. Arkansas’ constitution caps non-bank rates at 17 percent.

But even there, the industry managed to operate for nearly a decade until the state Supreme Court finally declared those loans usurious in 2008.

The state-by-state skirmishes are crucial, because high-cost lenders operate primarily under state law. On the federal level, the recently formed Consumer Financial Protection Bureau can address “unfair, deceptive or abusive practices,” said a spokeswoman. But the agency is prohibited from capping interest rates.

In Ohio, the lenders continue to offer payday loans via loopholes in laws written to regulate far different companies — mortgage lenders and credit repair organizations. The latter peddle their services to people struggling with debt, but they can charge unrestricted fees for helping consumers obtain new loans into which borrowers can consolidate their debt.

Today, Ohio lenders often charge even higher annual rates (for example, nearly 700 percent for a two-week loan) than they did before the reforms, according to a report by the nonprofit Policy Matters Ohio. In addition, other breeds of high-cost lending, such as auto-title loans, have recently moved into the state for the first time.

Earlier this year, the Ohio Supreme Court agreed to hear a case challenging the use of the mortgage law by a payday lender named Cashland. But even if the court rules the tactic illegal, the companies might simply find a new loophole. In its recent annual report, Cash America, the parent company of Cashland, addressed the consequences of losing the case: “if the Company is unable to continue making short-term loans under this law, it will have to alter its short-term loan product in Ohio.”

Amy Cantu, a spokeswoman for the Community Financial Services Association, the trade group representing the major payday lenders, said members are “regulated and licensed in every state where they conduct business and have worked with state regulators for more than two decades.”

“Second generation” products

When unrestrained by regulation, the typical two-week payday loan can be immensely profitable for lenders. The key to that profitability is for borrowers to take out loans over and over. When the CFPB studied a sample of payday loans earlier this year, it found that three-quarters of loan fees came from borrowers who had more than 10 payday loans in a 12-month period.

But because that type of loan has come under intense scrutiny, many lenders have developed what payday lender EZCorp chief executive Paul Rothamel calls “second generation” products. In early 2011, the traditional two-week payday loan accounted for about 90 percent of the company’s loan balance, he said in a recent call with analysts. By 2013, it had dropped below 50 percent. Eventually, he said, it would likely drop to 25 percent.

But like payday loans, which have annual rates typically ranging from 300 to 700 percent, the new products come at an extremely high cost. Cash America, for example, offers a “line of credit” in at least four states that works like a credit card — but with a 299 percent annual percentage rate. A number of payday lenders have embraced auto-title loans, which are secured by the borrower’s car and typically carry annual rates around 300 percent.

The most popular alternative to payday loans, however, are “longer term, but still very high-cost, installment loans,” said Tom Feltner, director of financial services at the Consumer Federation of America.

Last year, Delaware passed a major payday lending reform bill. For consumer advocates, it was the culmination of over a decade of effort and a badly needed measure to protect vulnerable borrowers. The bill limited the number of payday loans borrowers can take out each year to five.

“It was probably the best we could get here,” said Rashmi Rangan, executive director of the nonprofit Delaware Community Reinvestment Action Council.

But Cash America declared in its annual statement this year that the bill “only affects the Company’s short-term loan product in Delaware (and does not affect its installment loan product in that state).” The company currently offers a seven-month installment loan there at an annual rate of 398 percent.

Lenders can adapt their products with surprising alacrity. In Texas, where regulation is lax, lenders make more than eight times as many payday loans as installment loans, according to the most recent state data. Contrast that with Illinois, where the legislature passed a bill in 2005 that imposed a number of restraints on payday loans. By 2012, triple-digit-rate installment loans in the state outnumbered payday loans almost three to one.

In New Mexico, a 2007 law triggered the same rapid shift. QC Holdings’ payday loan stores dot that state, but just a year after the law, the president of the company told analysts that installment loans had “taken the place of payday loans” in that state.

New Mexico’s attorney general cracked down, filing suits against two lenders, charging in court documents that their long-term products were “unconscionable.” One loan from Cash Loans Now in early 2008 carried an annual percentage rate of 1,147 percent; after borrowing $50, the customer owed nearly $600 in total payments to be paid over the course of a year. FastBucks charged a 650 percent annual rate over two years for a $500 loan.

The products reflect a basic fact: Many low-income borrowers are desperate enough to accept any terms. In a recent Pew Charitable Trusts survey, 37 percent of payday loan borrowers responded that they’d pay any price for a loan.

The loans were unconscionable for a reason beyond the extremely high rates, the suits alleged. Employees did everything they could to keep borrowers on the hook. As one FastBucks employee testified, “We just basically don’t let anybody pay off.”

“Inherent in the model is repeated lending to folks who do not have the financial means to repay the loan,” said Karen Meyers, director of the New Mexico attorney general’s consumer protection division. “Borrowers often end up paying off one loan by taking out another loan. The goal is keeping people in debt indefinitely.”

In both cases, the judges agreed that the lenders had illegally preyed on unsophisticated borrowers. Cash Loans Now’s parent company has appealed the decision. FastBucks filed for bankruptcy protection after the judge ruled that it owed restitution to its customers for illegally circumventing the state’s payday loan law. The attorney general’s office estimates that the company owes over $20 million. Both companies declined to comment.

Despite the attorney general’s victories, similar types of loans are still widely available in New Mexico. The Cash Store, which has over 280 locations in seven states, offers an installment loan there with annual rates ranging from 520 percent to 780 percent. A 2012 QC loan in New Mexico reviewed by ProPublica carried a 425 percent annual rate.

“Playing Cat and Mouse”

When states — such as Washington, New York and New Hampshire — have laws prohibiting high-cost installment loans, the industry has tried to change them.

A bill introduced in Washington’s state senate early this year proposed allowing “small consumer installment loans” that could carry an annual rate of more than 200 percent. Though touted as a lower-cost alternative to payday loans, the bill’s primary backer was Moneytree, a Seattle-based payday lender. The bill passed the state senate, but stalled in the house.

In New Hampshire, which banned high-cost payday loans in 2008, the governor vetoed a bill last year that would have allowed installment loans with annual rates above 400 percent. But that wasn’t the only bill that high-cost lenders had pushed: One to allow auto-title loans, also vetoed by the governor, passed with a supermajority in the legislature. As a result, in 2012, New Hampshire joined states like Georgia and Arizona that have banned triple-digit-rate payday loans but allow similarly structured triple-digit-rate auto-title loans.

Texas has a law strictly limiting payday loans. But since it limits lenders to a fraction of what they prefer to charge, for more than a decade they have ignored it. To shirk the law, first they partnered with banks, since banks, which are regulated by the federal government, can legally offer loans exceeding state interest caps. But when federal regulators cracked down on the practice in 2005, the lenders had to find a new loophole.

Just as in Ohio, Texas lenders started defining themselves as credit repair organizations, which, under Texas law, can charge steep fees. Texas now has nearly 3,500 of such businesses, almost all of which are, effectively, high-cost lenders. And the industry has successfully fought off all efforts to cap their rates.

Seeing the lenders’ statehouse clout, a number of cities, including Dallas, San Antonio and Austin, have passed local ordinances that aim to break the cycle of payday debt by limiting the number of times a borrower can take out a loan. Speaking to analysts early this year, EZCorp’sRothamel said the ordinances had cut his company’s profit in Austin and Dallas by 90 percent.

But the company had a three-pronged counterattack plan, he said. The company had tweaked the product it offered in its brick-and-mortar outlets, and it had also begun to aggressively market online loans to customers in those cities. And the industry was pushing a statewide law to pre-empt the local rules, he said, so payday companies could stop “playing cat and mouse with the cities.”

Jerry Allen, the Dallas councilman who sponsored the city’s payday lending ordinance in 2011, said he wasn’t surprised by the industry’s response. “I’m just a lil’ ol’ local guy in Dallas, Texas,” he said. “I can only punch them the way I can punch them.”

But Allen, a political independent, said he hoped to persuade still more cities to join the effort. Eventually, he hopes the cities will force the state legislature’s hand, but he expects a fight: “Texas is a prime state for these folks. It’s a battleground. There’s a lot of money on the table.”



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National Spot Exchange: How it claimed it worked

A sudden turn of events has brought a functioning commodities market to a crashing halt. How did the National Spot Exchange function? Here is a Moneylife interview with NSEL’s top management with verbatim answers

National Spot Exchange (NSEL), promoted by Financial Technologies (FT), is in news for alleged violation of norms and is struggling to ensure a smooth closure of existing contracts. Sometime back, we had asked how NSEL functioned, its business model, security of its traders and its warehousing facilities. We started by asking an entity called Indian Bullion Market Association, which sounds like an association, but is a registered member of NSEL and promoted by NSEL.


Moneylife: The trend in prices on the NSEL seem to indicate an arbitrage between T+2 and T+25, directly linked to cost of money and geared to yield a return of around 14%. In fact, leading PMS companies have openly told us that this is a way of earning risk-free money with a yield of around 14%. Is this true?

NSEL: In physical trade, a trader or stockiest buys from mandi on cash payment and supplies to a mill, getting his payment from the mill after 15-25 days (varies from commodity to commodity and place to place). If the supplier insists for cash payment, the mill applies a CD (cash discount of 2%).  Hence, the interest rate prevalent in physical trade of commodity varies from 24% to 30% per annum. Compared to that, on NSEL, the cost of money involved in procurement has come down to 15%, which is beneficial to the processor. On the other hand, traders get a comfort of risk free environment, because of risk management and clearing house services provided by the NSEL.


Moneylife: Why the trading volumes for the T+2 contract and the T+25 contract are identical in many cases?

NSEL: In T+2 contracts, farmers, producers and traders sell commodities for delivery on T+2 days and they get payment on T+2 days. The actual users, processors and exporters, buy commodities in T+25 contracts, make payment on T+25th day and get delivery. An investor buys the commodity in T+2 contract and sells the same in T+25 contract. As a result, trading volume for T+2 and T+25 is identical. All such trades are backed by physical delivery of goods and warehouse receipts. To simplify this for your understanding, let’s take the global model of LME of T+90 days that covers 95% of physical trade in non-ferrous metals, as an example. Producers, consumers and intermediaries use this LME forward for their consumption, financing and hedging requirements. There is, however, a big lacuna in India-the set up does not address the key pillars of spot, forward and futures and does not complete the linkages of any commodity ecosystem. In India, we have tried to develop this in few agricultural commodities, so that the model can be tested on pilot basis.


Moneylife: How is the price of a product, even if it opens at high and closes on low, the same or almost the same?

NSEL: In the spot market for agricultural commodities, prices do not keep on changing, because there is no speculative element. Prices are influenced by mandi auction and once the auction is over, prices do not change much. Volumes are linked to arrival of commodities at our centre and they are not connected with price fluctuation or change in open, high, low, close, as mentioned by you. We do not find any intra-day trading in most of the agricultural commodities. The reason is that once a farmer, producer and trader has sold the commodity, he has no intention to buy it back but in delivering it and receiving his money. Similarly, once an actual user, exporter and processor has bought the commodity, he does not intend it sell it back, because he needs the commodity for processing or export. In brief, spot market of agricultural commodities do not function like a typical financial market, rather they function as electronic agricultural produce market committee (APMC), where flow of a commodity in a single day is from farmers to trader to end user and not vice versa.


Moneylife: Are we correct in our understanding that there is a single counter party for each specific contract?

NSEL: In agricultural commodities, the market structure is such that on sale side, there would be hundreds of sellers, while the buy side will consist of a few processors and exporters, who are interested in procuring commodities from an area that is not too far from his plant.


Moneylife: For raw wool, castor seeds, steel and paddy, which are the counter-parties involved?

NSEL: In castor seeds, all the large exporters of castor oil-Jayant Agro Organics, NK Proteins and AWN (a joint venture promoted by Adani Wilmer group) are our members. On sale side, large number of traders, commission agents and farmers are involved. Gujarat Agro Industries, a Gujarat government company is also our member. Similarly, in raw wool, ARK Imports, which imports raw wool from Australia, processes it and sells it to garment producers, is our member. In Paddy, Dunar Foods International, Vir Food, Namdhari Foods International Ltd, Namdhari Rice and General Mills Ltd, which process and sell rice in domestic market as well as international market, are our members. These names are only illustrative in nature. NSEL has a membership base of over 800 members, consisting of large government companies such as MMTC (Minerals and Metal Trading Corp, PEC, State Trading Corporation (STC), NAFED, RAJFED, Gujarat Agro Industries Corp, Food Corporation of India (FCI), Cotton Corp of India (CCI), APMARKFED, farmers’ societies, large broking houses and a number of corporates.


Moneylife: Where are your warehouses located? What is the process of inspecting the warehouse and ensuring that goods are actually stored there?

NSEL: Most of our warehouses are located near arrival centres. NSEL has, till date, launched 668 contracts on its platform. For launch of every contract, the Exchange issues a circular, which is available on our website and addresses of each warehouse have been specified. Further, there are service level manuals (SLMs), which are in existence for last five years. On a daily basis, goods come or go out and such movement of goods from warehouses is much more as compared to those in warehouses of futures market.


Moneylife: Are warehousing receipts (WRs) issued by the Exchange? Why do some investors tell us that they simply do not get warehousing receipts that can be pledged with banks?

NSEL: We have implemented electronic Warehouse Delivery and Management System (eWDMS) at NSEL. This system keeps track of all deliveries and warehouse receipts issued, discharged, surrendered, transferred and pledged. In case of physical warehouse receipt, we face problem because of time involved in sending receipts from one place to another and then receiving it back, if the buyer sells in between. For instance, NSEL is based in Mumbai and all WRs are generated from a centralized server based in Mumbai. Let us say a member is based at Kolkata, his franchise is based at Jaipur and the client is based at Jodhpur. In this case, if NSEL sends a warehouse receipt to its member at Kolkata, he will send it to his franchise at Jaipur and the franchise will send it again to his client at Jodhpur. This entire process will take at least 8-9 days. If the client sells such WR back on NSEL platform while the WR is still in transit, the entire thing would become a mess. Hence, we evolved a mechanism to sort out this issue.


When a client buys a commodity, we send an allocation letter to him by fax or scanned copy by mail on delivery date, while the WR is captured in eWDMS system. If the client sells it back, he is required to communicate the WR number and we mark his delivery based on the information provided. However, we are further working on automating the issuance of allocation letters.


We have provided web access to our members to access eWDMS directly from their location, so that paper work and courier/ fax work can be avoided. Besides, some members, who buy agri-commodities on our platform and are not interested in selling it back soon, send us requests for warehouse receipts and we provide physical receipts to them. Such members are also able to pledge WRs with the bank. However, in case of frequent buying and selling, movement of physical warehouse receipts is practically not feasible. At present, NSEL is operational in 16 states in India, providing delivery-based spot trading in 56 commodities across 192 delivery locations. The e-series has seven commodities available for trading. During FY2012-13, NSEL recorded a turnover of Rs2.95 lakh crore.


Moneylife: Would you also give us a break up of the outstanding position of a set of commodities traded on the exchange - for instance e-gold, raw wool, paddy, castor seeds etc and how many parties holds positions in each?

NSEL: In spot exchange, there is no outstanding position carried forward to the next day. Intra-day trading is possible, but all outstanding position at end of day are marked for delivery, which implies that seller has to give delivery and buyer has to take delivery. If the seller fails to give delivery, the Exchange conducts short delivery auction on T+2 day. For instance, at end of a particular day, there are thousands of investors holding buy and sell positions in e-gold and all these positions are settled by delivery on T+2.


Moneylife: Could you give us the locations of warehouses for each product and the process of inspection / regulation, if any?

NSEL: As explained, location of warehouses is given in the circulars issued for launching contracts for trading and subsequent circulars issued in continuance thereto, for adding new warehouses, which are available on our website. The Exchange avails the services of professional warehouse management companies such as Brink’s Arya, Group 4, Sohanlal & Co and National Bulk Handling Corp (NBHC) for managing warehouses. Brink’s Arya is a part of Brinks USA, duly approved by LBMA for handling delivery of gold and silver.  At some locations, where these professional companies do not have warehouses, we have put our own work force to manage warehouses for agricultural commodities. We have complete Management Information System (MIS) of all these warehouses. Issuance and transfer of WRs and discharge thereof, is handled from our central office. Besides, we have our inspection team to visit these warehouses regularly.


Moneylife: What are the activities and objectives of Indian Bullion Market Association (IBMA)? Is it a sub-broker of the exchange? What is its ownership structure? Why is it called an association?

NSEL: IBMA was setup to represent matters relating to bullion trade and industry on the physical side, before various authorities and ministries, who are involved in policy formulation. This role has now been extended to agriculture based commodities. The futures market’s views regarding policy formulation are being represented by several national and regional level commodity exchanges. It, however, lacked adequate representation by physical market participants (to which futures market is an adjunct). Due to this gap, physical market participants did not have enough say in policies formed by state governments, warehousing regulators and ministries related to commodities.


While physical markets are the largest employment generators, these markets are small and fragmented, consisting of participants speaking regional languages, who may not be able to articulate policy amendments. They function without any institutional set up, suffer from poor infrastructure and lack professional representation.


This leads to a huge gap between the policy and 'on ground' reality. After its formation, IBMA started contributing to policy formation in several ministries such as Ministry of Consumer Affairs (MCA), Ministry of Agriculture and Ministry of Finance. These ministries have also accepted and invited us in many official committees to represent physical trade.


IBMA is not a sub-broker but a member of the Exchange (NSEL). It has around 130 bullion dealers and jewellers from across the country as its shareholders. PEC Ltd (formerly Project & Equipment Corporation of India Ltd), a government company, is also its shareholder. It was conceptualized and called an 'Association' because it was promoted by NSEL in a cooperative structure along with various stakeholders such as small jewellers and bullion traders, with an aim to work as an aggregator.


Just as National Agricultural Cooperative Marketing Federation of India Ltd (NAFED), Haryana State Cooperative Supply and Marketing Federation Ltd (HAFED) and marketing federation (MARKFED) function as aggregators for providing market linkage to small and marginal farmers through a network of societies; NSEL provides market linkage to large number of constituents in 18 states that is registered in, with their respective state authorities and regulatory agencies.


In addition to making representations on behalf of physical market participants, policy makers and market linkages services, IBMA also offers various services to its members such as sourcing of material, clearing and forwarding (C&F).



Dilip Jain

4 years ago

What the top management at NSEL is telling about system looks so innocent apparently and well for theory, but practically some thing else has happened. If the system is so simple then why all the processors are not paying on due date i.e.on T+25th days. Had everyone adhered to due dates, no payment crisis would have emerged.(As explained by the management, the processor pays on T+25th day and lift the delivery. And for the new commodity i.e. fresh arrivals he enters into new contract if he wants. But he pays for the old contract irrespective of whether he enters into new contract or not)Then if Govt has asked to close down the NSEL, why they are refusing to pay and lift the delivery because each contract is independent contract. It means NSEL was not working as it was claiming and some one should go deep into the working style of NSEL and bring the true story.

Dayananda Kamath k

4 years ago

it is short sighted actions of the govt that led to such a mess. because the start as well as end of the nsel is dependent on amendments made to the law. nsel is was started when they amended the act in such a way that no regulator is there to monitor the exchange. when t+25 mode is there means it is futures transaction. for 3 years you allowed to function like this. one of the reason for inflation may be this also becasue rate is automatically inflated by 14%interest once in 25 days. then suddenly you bring an regulator by amendment to the law. and the regulator finds that all is not well. suddenly stops the transaction by govt notification. instead of suddenly stoping transactions they could have solved it gradually by giving time to correct it. now this step has made people doubt about the exchanges functioning in india. it has come at a worst time when indian economy has been brought to its knees by such acts.

A Kumar

4 years ago

Exchanges in India need to move to ECS mode of payment from their Member-Brokers which already have the same from their clients in majority of cases.


4 years ago

Very faulty system of trade. no wonder NSEL & FT are in trouble

arun adalja

4 years ago

we are living in electronic age and everything is possible to send documents by internet in a second so they can do everything to sort out the issue if they want to wor professionaly.i think fmc must do research to avoid mess created by nsel.

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