Working Paper: NBER ID: w27783
Authors: Sarah Miller; Cindy K. Soo
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.
Keywords: payday loans; credit access; subprime borrowers; bankruptcy; credit scores
JEL Codes: G5; G51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in credit scores (G51) | Higher credit limits (G51) |
| Increase in credit scores (G51) | Higher approval rates for traditional credit products (G21) |
| Removal of bankruptcy flag (K35) | Increase in inquiries for payday loans (G51) |
| Removal of bankruptcy flag (K35) | Increase in use of alternative credit products (G51) |
| Improved access to traditional credit (G21) | No significant reduction in payday loan dependence (G51) |
| Removal of bankruptcy flag (K35) | Increase in credit scores (G51) |