Does Increasing Access to Formal Credit Reduce Payday Borrowing?
The use of high cost “payday loans” among subprime borrowers has generated substantial concern among policymakers. This paper provides the first evidence of substitution between “alternative” and “traditional” credit by exploiting an unexpected positive shock to traditional credit access among payday loan borrowers: the removal of a Chapter 7 bankruptcy flag. We find that the removal of a bankruptcy flag on a credit report results in a sharp increase in access to traditional credit and raises credit scores, credit card limits, and approval rates. However, despite meaningful increases in access to traditional credit, we find no evidence that borrowers reduce their use of payday loans, and our confidence intervals allow us to rule out even very small reductions in payday borrowing. Furthermore, we find evidence that flag removals increase the use of other alternative credit products such as online subprime installment loans. These results indicate that marginally improving access to less expensive formal credit is insufficient to meaningfully shift borrowers away from high cost subprime products. We discuss likely explanations for this including increased marketing of subprime products associated with the flag removal, the imperfect substitutability between cash and credit for low income borrowers, and an insufficiency in the size of the increase in credit access associated with the flag removal.
The authors thank seminar participants at the University of Michigan, the NBER Summer Institute Corporate Finance meeting, and the Colorado Finance Summit, as well as Christopher Palmer for helpful feedback. We also thank Cathleen Kelmar for assistance with the provision of the Experian credit report data, and Heather Lamoureux for assisting with the provision of the alternative credit data from Clarity Services, Inc. Thanks also to Peter Choi for his excellent research assistance. The results presented in this paper do not reflect the opinions of the aforementioned institutions, nor do they necessarily reflect the views of the National Bureau of Economic Research.