In the Red: Overdrafts, Payday Lending and the Underbanked
The reordering of transactions from "high-to-low" is a controversial bank practice thought to maximize fees paid by low-income customers on overdrawn accounts. We exploit multiple class-action lawsuits resulting in mandatory changes to this practice, coupled with payday lending data, to show that after banks cease high-to-low reordering, low-income individuals reduce borrowing from alternative lenders. These consumers increase consumption, experience long-term improvements in overall financial health, and gain access to lower-cost loans in the traditional system. These findings highlight that aggressive bank practices create a demand for alternative financial services, highlighting an important link between the traditional and alternative financial systems.
We thank John Campbell, Mihir Desai, Luis Viceira, Adi Sunderam, Jialan Wang, Giorgia Piacentino, Adair Morse, and Emily Gallagher for helpful comments. We also thank numerous conference and seminar participants for helpful comments. Ma gratefully acknowledges support from the Paul & Daisy Soros Fellowship and the NSF Graduate Research Fellowship. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.