Brian Dijkema is vice-president of external affairs at the Canadian think tank Cardus. Johanna Lewis is a researcher at Cardus.
Interest rates are on the rise. Or are they? While rates for most borrowers grew over the past two years, payday-loan rates (loans of $1500 or less, for terms of 62 days or fewer) have been dropping.
The 2023 federal budget moved to impose a uniform fee of $14 per $100 borrowed across the country – after provinces had already been slashing their own rates in a series of massive changes to the sector.
In the past seven years, every province except Manitoba has reduced the maximum legal cost of a payday loan in an effort to protect vulnerable borrowers. Viewed as a change in annual percentage rates (APR) on a typical loan, these reductions have been significant: with savings ranging from a 23-per-cent decline in APR in Nova Scotia to a whopping 40-per-cent drop in Prince Edward Island. Now, the federal rules make such loans even cheaper.
Some of these changes have doubtless translated to real savings for vulnerable borrowers. Viewed as the dollar savings on a typical loan, however, the interest cuts appear less dramatic.
Take Alberta as an example. Someone who took out a $500 payday loan in 2016 would owe $615 ten days later. The same loan in 2023 under the federal rules would cost $570. For someone facing a severe cash crunch, the extra $45 is doubtless appreciated. But they didn’t take out a payday loan because they were short $45. They took the loan because they were short $500.
Payday loans are awful, but they are often the best of a suite of worse choices that include: not being able to put food on the table, bank fees for bounced checks or paying a reconnection fee for the hydro bill you can’t pay.
The problem with payday loans is less the interest charges (though they are brutally expensive) and more that the full cost of the loan – interest and principal – is due back all at once by the next payday. As we have stressed in our previous papers, this structure “effectively moves the burden of illiquidity from one pay period to the next.”
The federal government’s actions should be seen in the same light: nice, maybe, but unlikely to make a real difference in the lives of lower-income people.
Moreover, our research shows that there is a real possibility that the rate change might constrain the choices of low-income Canadians even more.
Provinces have made similar moves before. When we did research after the provincial rate reductions, we discovered significant consolidation in the industry; small providers went out of business, larger players such as Money Mart gained more market share, and the total number of providers fell.
Ontario, for instance, has lost nearly 30 per cent of its shops from 2016 to 2023, with the number of lenders declining sharply the year after the province cut maximum interest rates. This is in line with Cardus research using financial data from big payday-loan firms that showed that the break-even rate for lenders to be $14 per $100. It’s entirely likely that the federal rate mandate will expedite these closings.
Where will that leave low-income Canadians?
Sadly, neither the federal nor provincial governments have a clue. These new rules have assumed, rather than proved, that fewer lenders will benefit consumers.
Research shows that the industry has adapted; after the provinces changed their rules, payday-loan stores are being replaced by term loans and high-cost lines of credit – which unlike payday loans are not used for small amounts – and results are beginning to show in consumer behaviour. Insolvency trustees and economic empowerment groups are noting an increase in the average size of loans, indicating that consumers might be borrowing at lower interest rates, but they’re borrowing a lot more.
Our research shows that much these bigger loans were likely not used to cover emergency needs, and borrowers ended up rolling them over when they could not repay. What used to be a small but expensive loan that was covered by the next payday has turned into larger, permanent loans that simply cannot be covered by asset-limited, income-constrained, employed customers.
And as with gambling and pornography, it’s possible that the decline in options has driven more people to unregulated online lenders (which is a challenge in Quebec, where payday loans are illegal).
To be sure, the data do suggest that these previous provincial approaches, while not perfect, had some innovations – like Ontario’s requirement to give borrowers who took out multiple payday loans extended payment plans – that actually addressed some real challenges.
But what has been missing from this discussion are economically viable alternatives. Early attempts at popular options, such as postal banking, failed miserably and credit-union alternatives amounted to a total – wait for it – .09 per cent of all loan volume.
The Big Five banks are the only players with the economic clout to create viable alternatives to payday loans. In the absence of federal pressure on them to do so, it’s possible that the old provincial system was the best we could get, and that these recent steps will make a bad scene worse.