Payday Rulemaking: Is Too Much Competition a Bad Thing?

The CFPB's proposed payday rule making is out.  There's a nice summary here.  

I'm going to reserve comment other than to note a critical implication of a rare area of agreement between the supporters and opponents of the payday rule:  it will result in a lot of payday lenders closing up shop.  That might be just what the industry needs.

Payday lending differs materially from bank lending in (among things) that there are very low barriers to entry.  Bank regulators restrict the number of bank charters in order to reduce interbank competition. (What was that about free markets, Jamie Dimon?) That mode of regulation does not exist in payday, and it results in a self-cannibalization of the industry. Most storefront lenders have very few actual customers--a few hundred per store per year. Often stores average less than one customer per day (offset only partially by the fact that these customers tend to take out multiple loans). That means that payday lenders have to amortize their fixed and semi-fixed costs over a small borrower base, which in turn results in very high priced loans even without outsized profit margins. (This also suggests that bank payday lending, like Postal payday proposals, is economically more feasible because of a broader base over which to spread fixed costs.) In other words, too much competition is actually pushing up prices.  

The situation is somewhat analogous to a population of deer (or wolves) that grows too large for the sustenance base.  The resulting overgrazing (or overpredation) can ultimately result in a catastrophic collapse.  The typical wildlife husbandry solution is to cull the herd in order to ensure that the survivors are stronger and healthier.  Regulations that have the effect of reducing the number of lenders can be thought of as functioning in a similar way. In banking, this is done through control over chartering. Insurance does this through rate regulation (preventing destructive rate races). The CFPB's rulemaking is likely to achieve something similar in payday lending. 

We've seen this happen before. In 2010 Colorado undertook a major regulation of its in-state payday industry (this after an unsuccessful round of regulation in 2007). Pew has nicely analyzed the results.  The result of the regulation was that the number of in-state payday lenders fell by half (-53%).  Demand slackened only a little (-7%; why would it disappear?), however, so the number of customers per storefront almost doubled (up 99%).  The terms borrowers received were much better under the Colorado reform, and the revenue per store increased (+26%).  

What the Colorado experience suggests is that it's possible to have both better loan terms for consumers, and a healthier payday lending industry, but only if there is a contraction in the number of lenders. Put another way, some lenders have to go out of business in order for others to do better and for consumers to get better terms. It's rather counterintuitive--normally we think of competition as an important force for consumer protection, but at a certain point, it seems, too much competition actually results in price increases.  But it goes to show that the free market may not always produce the socially efficient result. (Obviously this isn't Pareto efficient, but it could well be Kaldor-Hicks efficient.) Curious to hear thoughts.