Does Increasing Access to Formal Credit Reduce Payday Borrowing?

53 Pages Posted: 11 Sep 2020 Last revised: 1 Jun 2022

See all articles by Sarah Miller

Sarah Miller

University of Michigan at Ann Arbor

Cindy Soo

University of Michigan, Stephen M. Ross School of Business

Date Written: September 2020

Abstract

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.

Suggested Citation

Miller, Sarah and Soo, Cindy, Does Increasing Access to Formal Credit Reduce Payday Borrowing? (September 2020). NBER Working Paper No. w27783, Available at SSRN: https://ssrn.com/abstract=3687939

Sarah Miller (Contact Author)

University of Michigan at Ann Arbor ( email )

500 S. State Street
Ann Arbor, MI 48109
United States

HOME PAGE: http://www-personal.umich.edu/~mille/

Cindy Soo

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street, Ross School of Business
University of Michigan
ANN ARBOR, MI MI 48104
United States

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