The proposed Consumer Financial Protection Agency was supposed to regulate payday loans -those extremely high interest rate short term loans- but it now appears that it may not. This could turn out to be a good thing for consumers, since the best way to help payday borrowers might be to deregulate the industry…. Bare with me, I know that sounds ridiculous.

A recent paper from Robert DeYoung and Ronnie Phillips at the Kansas City Fed provides some cautionary results about potential negative side effects of increasing regulation, and suggests possible positive impacts of deregulation. What they find is that more competition among payday lenders can decrease the exorbitant interest rates on payday loans. Increasing competition decreases prices; this is not so surprising.

The authors even go so far as to suggest increasing competition by removing regulations that limit the ability of local banks, thrifts, and credit unions to offer payday loans. This makes sense, since reputation is probably more important to local banks, thrifts, and credit unions than it is to payday lenders, they would be more likely to offer actuarily fairly priced payday loans and less likely to try and manipulate borrowers with confusing contracts, etc. In fact, DeYoung and Phillips provide evidence that payday lenders with large franchises are less likely than mom-and-pop stores to engage in exploitative pricing behaviors. Getting banks and other financial institutions into payday lending could help prevent a “race to the bottom” in lending standards that might otherwise result from increasing competition.

Another caution provided by DeYoung and Phillips is that setting a rate cap may provide a Schelling point for payday lenders to collude around, so that for many borrowers rates could actually go up. What this means is that the payday lending industry has the market concentration to collude, but without explicitly communicating with each other (“Hey, if you charge 1,000% and I’ll charge 1,000% too) they cannot find a stable equilibrium price point to settle on, thus the resulting market is somewhat competitive. A rate cap provides them with a natural price point to collude around. So if the government says “You can’t charge more than X%”, then that rate becomes a Schelling point and all lenders begin collusively charging X% for all loans, which can actually be a higher price point than they were previously charging for many loans. The evidence they provide is not conclusive, but it is consistent with studies that have shown similar responses resulting from credit card rate ceilings.

I would not say this paper is conclusive enough to declare that these impacts are what will occur if we get national rate capes for payday loans. But as we debate whether payday lending should get regulated as a part of the CFPA, these possible outcomes and deregulatory means to improving the industry are worth thinking about.