It is a criminal offence for banks, credit unions and anyone else in the lending business to charge an annual interest rate of more than 60%. Yet many if not most payday lenders exceed this rate once interest fees and charges are combined. It’s a slippery situation that the federal government hopes to address with Bill C-26.

The new law, now making its way through the legislative process, will remove restrictions originally intended to curtail organized crime activity, allowing payday lenders greater freedom on charges. Bill C-26 also gives provincial governments the authority to regulate payday lenders. The onus is now on the provinces to deal with payday lenders on their turf.

The federal government maintains Bill C-26 will make things better for borrowers by protecting “consumers from the unscrupulous practices of unregulated payday lenders,” says Conservative member of Parliament Blaine Calkins of Wetaskiwin, Alta.

But not everyone shares that optimism. Chris Robinson, a finance professor and co-ordinator of wealth-management programs at the Atkinson School of Administrative Studies at York University in Toronto, contends Bill C-26 will leave borrowers in the lurch.

“The government has simply abdicated the field,” says Robinson. “Payday lenders are making excessive profits already, and they will continue to make more. They need to be regulated. That will force them to be efficient and not destroy people who can’t afford it.”

At the heart of the controversy lies the growing popularity — and profitability — of payday lenders. The industry, slightly more than 10 years old in Canada, boasts annual revenue of roughly $1.7 billion and more than 1,300 storefront locations. “The industry appears to be filling a gap that exists in the availability of credit from the chartered banks and other traditional lending institutions,” according to Calkins.

But the service comes at a cost — one that can be exorbitant. A report prepared by Robinson for the Association of Community Organizations for Reform Now shows that the largest payday lending companies in Canada, including Cash Money, The Cash Store and Money Mart, usually charge a processing fee of at least 20%. Interest rates can hit 59% — not surprising, given the Criminal Code provisions.

As part of a report on the issue prepared for the federal government by the Parliamentary Information and Research Service, co-authors Andrew Kitching and Sheena Starky prepared an overview of a sample payday loan: someone who borrows $400 for 17 days might pay roughly $51.28 in interest and fees — which works out to an annual rate of interest of 1,242%.

Yet no one is going to jail for charging such fees, as commonplace as they may be. Part of the reason is the fact that the Canadian Criminal Code, as currently written, was never intended to apply to payday lenders. Rather, it was an attempt to curtail loansharking activities. “The adoption of a specific interest rate limit in the Criminal Code, immediately next to the provision for extortion, was to facilitate proof of extorted loans. This was clearly not about regulating legitimate lending activities,” says Calkins.

Robinson believes the reasons for the high rates on payday loans is the general inefficiency of the lending operations. Loans are usually small — an average of $280 — and run for a 10-day period on average. To operate, payday lenders must contend with fixed costs such as phone bills and rent. “They have to charge the earth,” says Robinson. “Fixed costs are the driving factors and account for 75% of the companies’ costs.”

But business is brisk. Berwyn, Penn.-based Dollar Financial Corp. , which trades on Nasdaq, operates 386 stores in Canada under the Money Mart name. Dollar Financial posted a year-over-year 23.2% increase in revenue to US$91.7 million in its first quarter ended Sept. 30, 2006. Revenue from international operations jumped 30.7% to US$15 million over the same period. However, the firm — the only publicly traded payday lender operating in Canada — reported a net loss of US$1.7 million in the quarter, vs net income of US$2.3 million in the first quarter of fiscal 2006.

Robinson says lending risk is manageable. Although payday lenders have a higher default rate than banks, at 2% to 3%, that rate remains relatively stable.

Growth and stability are attributes that appeal to all businesses, so it is not surprising that traditional lenders are vying to get a toehold in the payday-loan business. Credit unions are stepping up to the plate, with Alterna Savings Credit Union Ltd. , the second-largest credit union in Ontario, leading the charge.

@page_break@The credit union, which has 24 branches in Ottawa and Toronto, is about to become the first traditional financial institution in Canada to offer what it calls a “convenience loan.”

“Surveys have shown that between 1.5 million and 2 million Canadians are using payday loans, and 93% of them have chequing accounts with credit unions,” says Bob Whitelaw, director of the convenience loan project at Alterna Savings.

The intent, says Whitelaw, is to offer customers a service that is easy, risk-tolerant, socially responsible and that will start to break the cycle of dependency that many Canadians have on payday loans.

This new-found interest in short-term loans is not surprising. In the U.S., it is a growing area of business for credit unions. Of the 9,000 credit unions in the U.S., 1,000 currently offer payday loans.

Several payday lenders have responded favourably to Bill C-26, as has the Canadian Pay-day Loan Association. On the plus side, the legislation would mean companies cannot be fined up to $25,000 or management sent to jail for five years for violating Criminal Code provisions. On the flip side, it opens the door for the provinces to step in with their own legislation.

Three provinces have already done so, even though the federal changes are not yet law. Manitoba, British Columbia and Nova Scotia are moving forward with legislative amendments that will put control of payday lenders in their hands. Provinces that fail to introduce their own legislation will see payday lenders that operate on their patch fall under Bill C-26, which would exempt loans from the 60% rule if they do not exceed $1,500 or 62 days.

Manitoba’s new legislation, announced in the spring of 2006, will require companies to be licensed and bonded, and to alert borrowers about the high cost of the loans. The maximum cost of any loan will be set by the Public Utilities Board, and no additional fees will be allowed at the point at which loans are renewed, extended or replaced, unless authorized by the PUB.

In Nova Scotia, legislation is being spurred on by a court case that involves a payday lender and allegations that not all charges were disclosed before the loan was awarded.

“This is to protect consumers. It will enforce stricter guidelines,” says Lenore Bromley, spokeswoman for Service Nova Scotia and Municipal Relations, a provincial government department.

In this new legislative environment, other provinces will no doubt step up. Such guidelines are inevitable and intended to protect the consumer. Yet payday lenders, it appears, are ready for a bold, new world. IE