Should regulation be aimed at saving the payday borrower from themselves?

The fact that payday industry is marked by high interest rates, hidden charges, and has a vulnerable sector of the community as the target market inevitably means it is constantly scrutinised by regulators.

In March, payday lender Nimble ordered by the Australian Securities and Investment Commission (ASIC) to refund $1.5 million to more than 7000 customers after it found Nimble failed to make the proper inquiries about borrowers' financial circumstances and needs.

The regulation currently protects consumer payday borrowers but not small enterprise borrowers. Much of the regulation is aimed at protecting consumers from “bad loan products”, from stopping “bad lenders” from operating, and to make borrower “aware” of all the terms and conditions of the financial product they are about to purchase. This regulatory perspective makes sense on the surface and is mirrored in other developed countries.

But what if the borrowers who take these small loans actually need protecting from themselves, as much as from “bad loan” products in the market?

Current research has not considered the impact of trends in borrower personality characteristics on payday loans, and thus on the effectiveness of the regulation. However, preliminary research seems to indicate that there are a number of personality factors which may play a role. The key factors which potentially impact small size loan borrowers and their payday loan decisions are optimism and self control.

Trends in over-optimistic borrowers could have the potential to negate the protective intention of the regulation on consumer and enterprise loans. Authors have found that optimism can potentially weaken the effects of disclosure.

The ability to forecast the future is inherently tied to cognition, yet people are consistently unrealistic about their future.

Given that optimism leads to forecasting inaccuracy , poor decision–making, and that overly-optimistic people are more likely to become entrepreneurs, it can be intuitively argued that small size enterprise borrowers are likely to systematically miscalculate their future life outcomes.

Further, those with high levels of optimism are less sensitive to interest rates and less likely to “shop-around” for a better deal on their loan.

There may be systematic trends in the levels of optimism held by small loan borrowers in Australia. If this is the case, as the above research indicates, no amount of disclosure regulation will be able to save overly-optimistic borrowers from themselves.

When considering the self-sabotage that often occurs in personal financial plans, the topic of self control is controversial. This is because, in simple terms, it does not matter what one earns, it matters what one spends. Thus, it is the ability of those who are otherwise financially vulnerable, to maintain the financial resources they have, without spending, which occurs as a result of low self control.

This is critical when considering the effectiveness of the regulation around small loans, because self control has been found to be more important than financial literacy in explaining over-indebtedness. Yet, financial literacy is the focus in the media as well as academia, where pure knowledge of concepts is expected to become the band aid which will cure the poor decisions made by those least financially able to recover from those decisions.

Indeed, the resources which are allocated to financial literacy programs may be having such a small effect it could be better directed towards self-control programs and education. It is not only those financially vulnerable in our community who may succumb to issues with self control – it is safe to say that most people can identify with this challenge, particularly when relating to diet and eating choices.

Thus, it may not be that small loan borrowers are any different from the wider population, only that self-control issues are exhibited in different ways.

Regulation is designed to protect consumers by ensuring that they have adequate disclosure, and that “bad products” are not available for them to unknowingly purchase. However, consistent trends in high optimism and low self-control in the small loan borrower community may result in all of the well-intentioned regulation on this topic to be ineffective at best and harmful at worst.