Impacts of interest rate caps on the payday loan market: Evidence from Rhode Island

Abstract

Abstract Interest rate caps are the most common form of payday loan regulation, yet little academic research has examined their consequences. I investigate the impacts of tightening the cap from 15% to 10% in Rhode Island, using a difference-in-difference framework and a unique proprietary dataset of payday loans issued by major nationwide lenders between 2009 and 2013. Lenders always charge the prevailing cap, creating a sharp and clean variation in interest rate. I show that loan usage increases at the extensive and intensive margins, amounting to elasticity estimates in the range of 0.7–1.0. I also find that loan sequences become longer and more likely to end with default. No lenders exit the market, implying that market power existed. Furthermore, I find no evidence of credit rationing as a result of the lower cap. These changes imply an upper bound of $3.3 million per year for neoclassical consumer surplus. However, I show that behavioral consumers can be worse off by the policy if more than half of the increase in demand is due to overborrowing.