Section 2 provides background on the payday lending industry and the state regulations that affect it

Section 3 describes the data, the sources of regulatory variation, and the econometric specifications. Section 4 presents results using cross-state pooled regressions and within-state law-change regressions. Section 5 concludes.

Payday lending is widespread. FDIC (2013) estimates that 4.7% of all U.S. households have at some time used payday lending, while Pew Charitable Trusts (2012) puts the figure at 5.5% of U.S. adults. In 2005, payday storefronts outnumbered McDonald’s and Starbucks locations combined (Graves and Peterson, 2008). Lenders extended $40 billion in payday credit in 2010, generating revenues of $7.4 billion (Stephens Inc., 2011).

To date the federal government has not directly regulated payday lending (save via general statutes such as the Truth in Lending Act and the Military Lending Act), though this may change now that the Consumer Financial Protection Bureau (CFPB) has been given rulemaking authority over the industry

Traditionally, payday lending regulation has been left to the states. Prior to the mid-2000s, states’ ability to regulate payday lending was undermined by the so-called “rent-a-bank” model, wherein a local lender would partner with a federally-chartered bank not subject to that lender’s state laws, thereby importing exemption from those laws (Mann and Hawkins, 2007; Stegman, 2007). In the Federal Deposit Insurance Corporation (FDIC) issued guidance effectively prohibiting banks from using this model, giving state laws more bite.

The advent of online payday lending offers a potential alternative model for skirting state law. However, initial evidence suggests only very limited substitution between storefront and online payday products. Online payday customers tend to be younger, richer, and more educated than storefront customers, and states that ban storefront payday have virtually identical rates of online borrowing as states that allow storefront payday (Pew Charitable Trusts, 2012 ). This suggests that customers have not responded to more stringent state regulations by substituting toward online payday in appreciable numbers.

2 . 1 The payday lending model

A payday loan is structured as a short-term advance on a paycheck. The borrower provides proof of employment (usually via pay stubs) and writes a check for the principal of the loan plus the fee, post-dated for after the next hit website payday. For instance, a borrower might write a check for $345 and walk out with $300 in cash. Once the payday arrives the lender cashes the check written by the borrower.

Though payday loans are technically uncollateralized, the lender’s possession of the post-dated check (or, increasingly often, the permission to directly debit the borrower’s checking account) plays a collateral-like role. By taking the repayment decision out of the borrower’s hands, payday lenders effectively ensure they are repaid ahead of the borrower’s other debts and expenses. Though default is still possible, loss rates of around 3.5% of loan volume (Stephens Inc., 2011) are very low given borrower creditworthiness. 2 The high price of payday loans reflects their high overhead cost more than it does high losses from default. Stephens Inc. (2011) estimates that in 2010 losses comprised only 21% of total cost. 3

Because payday loans are typically due on the borrower’s next payday, terms of 14 days are common. Given prices around $15 per $100 borrowed, APRs are often in the range of 300%-500%. On the due date the whole amount of the loan is due in a single balloon payment. Borrowers wishing to renew their loan can theoretically recreate the structure of an amortizing loan by borrowing slightly less each time. In practice, it is much more common for customers to borrow the same amount with each renewal until such time as the loan can be retired.