Square’s Cash App apparently is testing a new lending product that will enable users to borrow between $20 and $200 dollars at a 5% fixed fee for four weeks plus 1.25% in non-compounding interest for each additional week borrowers extend their loans. The fixed fee averages 60% at an annual rate (APR), which is much lower than “payday” loan storefronts charge. By cross selling and leveraging its low fixed costs, Cash App can offer payday loans at much lower rates potentially preventing ‘debt traps’ and revolutionizing the single-payment credit market.
In 2017, 14,348 payday loan storefronts were ubiquitous in the US, outnumbering the 14,027 McDonalds and highlighting how many consumers are stretching to make ends meet. Each year, roughly 12 million Americans take out $27 billion in payday loans, racking up $4 billion in fees according to several estimates. Legal in only 32 states, the average payday loan APR is 391%, double that of a bounced check fee, nearly 3x the late fees on credit cards, and more than 6x those on late car payments.
Because 7 in 10 payday loans defray recurring expenses like rent and utilities, borrowers roll 80% into the next month and seek another loan within 14 days, essentially falling into debt traps. Defaulting on payday loans results in more onerous charges, including fees for overdrafts and for Non-Sufficient Funds (NSF).
Cash App is likely to disrupt and seize the traditional payday loan market in the absence of a competitive response. Payday lenders typically charge $15 per $100 borrowed over two weeks and an additional $15 per $100 for a two week rollover, turning an initial $200 loan with four rollovers into a $350 debt obligation in 10 weeks. In contrast, a $200 Cash App loan rolled over four times would mount to a $230 obligation, 35% less than the payday loan balance, over 10 weeks. Put another way, Cash App’s obligation after 10 weeks is equal to that due to typical payday lenders after only 2 weeks, without any roll-overs.
Federal Reserve Board Governor Lael Brainard announced Thursday that the Fed is testing a Central Bank Digital Currency (CBDC). Issued by the Fed, the CBDC would serve as digital legal tender, similar to cash, primarily for retail payments.
Reuters reported that the European Central Bank is discussing plans for a European public digital currency
While similar cosmetically to cryptocurrencies like bitcoin, a CBDC would pose more of a threat to commercial banks than to cryptocurrencies. A CBDC could eliminate any dependence on intermediaries by handling the functionality of payment services like account management and customer due diligence, specifically Know Your Customer (KYC) and Anti Money Laundering (AML).
Although the launch timing is uncertain, the Fed is partnering with the Massachusetts Institute of Technology (MIT) to develop the CBDC over the next two to three years. In the press release, Brainard acknowledged the existence of other CBDCs and private cryptocurrencies like bitcoin and Libra, underscoring the need to evaluate them in the US with the following comment: “This prospect has intensified calls for CBDCs to maintain the sovereign currency as the anchor of the nation’s payment systems. Moreover, China has moved ahead rapidly on its version of a CBDC.”
Borrowers in Texas pay an astonishing 661% APR on average for payday loans
Other central banks are evaluating digital currencies as well. Turkey also has announced plans, with trial runs expected by year end. Meanwhile, China continues to stand firm that it will launch its own digital currency this year, after planning and developing it for the past 5 years.