Last November, Manitoba began it’s crackdown on payday loan companies by forcing them to license. The business model is pretty simple: those that live paycheque to paycheque are short some weeks and need to borrow money. The companies in this market, which include MoneyMart, provide the service… for a heavy price. While Federal law defines criminal interest rates as 60% and above, many payday lenders get around the limits by charging administration or other fixed fees that make the effective interest rates much higher.
Manitoba is going the regulatory route, which is an important first step. But ultimately poor people need better access to credit — true in the developing world and the developed. Microcredit has been the focus of about 25,000 development economics papers (estimation by author) in the last 20 years. Microfinance operations were originally initiated by locally-led NGOs, who found that, to the surprise of many, dirt poor borrowers had repayment rates upwards of 99%. The private sector has learned from these findings to make money in the developing world lending small amounts of money at relatively low interest rates. For example, Scotiabank has microfinance operations in the Caribbean.
So why has the credit market failed the poor in Canada? I’m not exactly sure, but it likely has something to do with (a) lenders’ inability to be perfectly informed about the borrower’s repayment characteristics; and (b) lack of regulation, effectively letting lender’s get away with it.
Governments, through tax collection, administration of social programs, etc., have an informational advantage and, I suggest, would be able to run a fair and efficient lending program that relies upon the principles learned from the developing world experience. (Privacy concerns would of course have to be addressed.) Relative to other programs aimed at helping the poor, the program would be extremely cheap if not self sustaining (after an initial capital outlay), especially given governments cheap access to credit. The initiative could also involve borrowers working to organize and administer the program, ultimately a way to close the gap between designers and users of social programs. So Manitoba, what are you waiting for?