The Federal Reserve Bank of New York works to promote sound and well-functioning financial systems and markets through its provision of industry and payment services, advancement of infrastructure reform in key markets and training and educational support to international institutions.
The Outreach and Education function engages, empowers and educates the Second District communities that the Bank serves, especially civic leaders, students, educators, small business owners, policymakers and the general public. It furthers the Bank's commitment to the region by listening to the communities we serve and leveraging our unique attributes to positively impact school and university programs, as well as analysis and research.
We find that competition from payday lenders leads depository institutions to raise overdraft fees and reduce the availability of “free” checking accounts. We attribute this rise in prices partly to adverse selection created by banks’ practice of charging a flat fee regardless of the overdraft amount—pricing that favors depositors prone to large overdrafts. Payday credit is priced per dollar borrowed, so when that option is available, depositors prone to small overdrafts switch. That selection works against banks; large overdrafts cost more to supply and, if depositors default, banks lose more, so prices rise. Consistent with this adverse selection hypothesis, we document that the average dollar amount per returned check at banks and other depository institutions increases when depositors have access to payday credit. Our findings illuminate competition and pricing frictions in the large, yet largely unstudied, small-dollar loan market.