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 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 their borrowing from alternative lenders. These consumers increase consumption, experience long-term improvements in financial health, and gain access to lower-cost loans in the traditional system. These findings show that aggressive bank practices create a demand for alternative financial services, highlighting an important link between the traditional and alternative financial systems.

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

JEL Classification: G21, G23