Regulation on the Margin: Evidence from Online Payday Lending

Payday loans continue to be a commonly used yet controversial source of credit for low-income consumers. Regulation of this market must balance the beneficial uses of payday lending with harmful, inefficient uses that exacerbate financial hardship. The best way to strike this balance, we argue, is to regulate at the margin—that is, experiment with different types of regulation at the extensive margin and the stringency of those regulations at the intensive margin.

After highlighting common payday loan regulations and the conflicting evidence of their consequences, speaking primarily to regulation at the extensive margin, we present an empirical analysis utilizing proprietary data from a payday lender operating in Tennessee to demonstrate the effects of loan caps in a novel setting and highlight the benefits of regulation at the intensive margin. Specifically, we study the consequences of capping online payday loan size using a fuzzy regression kink design, exploiting exogenous variation in loan size generated by the interaction of the lender’s underwriting rules with a state loan-size cap. We exploit this variation to estimate the effect of capping loan sizes on total subsequent indebtedness from any type of subprime credit, late payment, and default. The analysis both improves our collective understanding of loan caps’ effects and shines light on an increasingly important, yet understudied, setting for subprime lending: online. 

Our results show that online payday loan borrowers are severely credit constrained and that restricting payday loan size increases subsequent indebtedness. These findings coupled with related but contradictory findings in settings where loan caps are higher suggest marginal tweaks to the state loan cap may benefit borrowers, demonstrating a real-life policy setting ripe for regulation at the margin.