Regulating on the Fringe: Reexamining the Link Between Fringe Banking and Financial Distress

Critics of fringe banking—products like payday loans, pawn loans, and rent-toown leases—frequently argue that these products cause borrowers to experience financial distress. This argument has enormous intuitive appeal: Fringe credit is very costly, and usually the borrowers who use it are already in a serious financial bind. Taking on additional debt and paying high prices for it, the reasoning goes, drive them over the brink. Surprisingly, however, linking financial distress to fringe banking is extremely difficult to do.

This Article represents the first attempt to uncover the relationship between fringe banking and financial distress by systematically analyzing the structure of fringe credit markets and the characteristics of specific fringe credit transactions. Contrary to the assumptions made by the bulk of the literature, I argue that the link between fringe banking and financial distress is dubious. Because fringe creditors cannot rely on borrowers’ credit scores to predict whether they will be repaid, creditors structure fringe credit products to virtually guarantee repayment. Because repayment is guaranteed by the structure of the transaction, it is nearly impossible for borrowers to take on unmanageable debt loads.

Yet, a significant amount of regulatory intervention into fringe banking markets is premised upon the relationship between fringe banking and financial distress. Policy makers lump fringe credit together with other forms of credit that do cause financial distress, resulting in misguided and overly broad policies. The Article concludes by exploring the policy implications of determining that fringe banking products do not cause distress.