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Free market may be best method for regulating short term lenders

Jul 30, 2013 Philip Burgess

Short term lending can help borrowers through a tough spot, granting them a financial reprieve until their next paycheck. Responsible parties then pay their debt and continue on with their lives. Businesses and private citizens alike can suffer brief cashflow problems. The previous state of the economy caused many individuals to have difficulty paying off a bill, and for some, short term loans provided a quick answer to what could have been a long term problem.

If anything, short term lenders became even more important during the last few years. With many banks tightening their restrictions on loans, a number of individuals required the services of lenders willing to help them. According to The Huffington Post, though, the Consumer Financial Protection Bureau (CFPB) may enact regulations that curb the ability of lenders to provide assistance to borrowers in need. The source noted that future restrictions may include a cooling off period that would prevent borrowers from taking out more than one loan between paychecks, or that would stop them from receiving a new loan until all pre-existing ones were paid in full.

A repeating pattern of regulation
This is not the first time that the government has attempted to impede the ability of lenders to issue short term loans. In a recent post on American Banker, Ted Saunders wrote that regulation will raise the price of loans. The Huffington Post claimed that the CFPB may require underwriting for the lending sector. Saunders remarked that if a $700 loan costs $500 to underwrite, that it is a poor investment for lenders.

The source further noted that the government and other critics of short term loans have attempted to provide low-interest alternatives, only for them to repeatedly fail. Finance-focused organizations that have made the effort were largely either forced to withdraw the offering or went out of business. Meanwhile, the government's 2008 Small-Dollar Loan Pilot Program that attempted to offer short term loans at 36 percent interest was deemed unprofitable and unsustainable by the Financial Services Centers of America, Inc. He added that if the costs associated with the industry did not reflect the price such businesses could afford to operate at, new competitors with decreased prices would enter the market.

Rather than further regulating the market, Saunders suggested that competition would be more effective at meeting consumer demand. Lenders would need to be more competitive with one another, offering better service lest would-be borrowers turn to another organization offering lower interest rates or a more accommodating repayment schedule.

Saunders also noted that better data and more customer-focused debt settlement could improve the short term lending market. Better information can reduce some of the costs associated with the industry by providing a greater understanding of some of the more subtle or complex habits and patterns of borrowers and lenders alike.

For now, many of the CFPB's regulations are still in the proposal stage. However, if they do become a reality, their continued existence is as uncertain as past attempts at changing the industry.