When my father was visiting last week he asked me to compare micro loans in developing countries with payday loans.
It’s a little long but this New Yorker article does a great job of explaining microcredit as does this shorter piece by Karol Boudreaux and Tyler Cowen. For those of you not familiar with micro lending, basically relatively poor people in developing countries are loaned small amounts of money (10s to 100s of dollars).
As the New Yorker article discusses interest rates for micro loans in developing countries can still approach over 100% APR a year. The article also contrasts two current models of micro loans, one which works as a non-profit and one which makes a profit. So what is different between micro credit and payday loans, besides a slightly smaller interest rate. In microloans in developing countries:
1.) The money is supposed to be used to purchase something that will help generate future income.
2.) Loans are made in typically smaller amounts at first then building to larger amounts as the borrower shows they can repay.
3.) Borrowers are often put into groups of about 10 members. All group members must repay their loans or all borrowers lose the ability to borrow in the future.
4.) The programs often include financial education, and require borrowers to save some part of their loan.
5.) Running loan offices may be cheaper in developing countries, since labor is often much cheaper in developing countries, so interest rates can be lower than in the US check cashing places.
So what is the answer to addressing the problems caused by check cashing/ payday loans places in the US. I think in part it creating a way to allow people to manage their finances better.
One step in the right direction might be the Russell Simons Rush Card. Its basically a pre-paid credit card. It also offers direct deposit and check cashing, at fees that seem lower than the average. The card is aimed at the millions of Americans who are without a bank account.
If this could be linked with microloan program that included grouping borrowers and perhaps financial education. I’m however unsure of the ability of the free market and the government to provide that financial education, so I guess it is up to teachers like me.