In the Red: Overdrafts, Payday Lending and the Underbanked

Abstract

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 a series of class-action lawsuits that mandated that some banks cease the practice. Using alternative credit bureau data, we find that after banks cease high-to-low reordering, low-income individuals reduce payday borrowing, increase consumption, undergo long-term improvements in financial health, and gain access to lower-cost loans in the traditional financial system. These findings, in suggesting that aggressive bank practices can create demand for alternative financial services, highlight an
important link between the traditional and alternative financial systems.

Keywords: overdraft, payday loans, excessive fees, underbank, underserved

JEL Classification: G21, G23