Ralph A. Young

English

Research Papers in Economics

This PDF is a selection from an out-of-print volume from the National
Bureau of Economic Research
Volume Title: Personal Finance Companies and Their Credit Practices
Volume Author/Editor: Ralph A. Young and associates
Volume Publisher: NBER
Volume ISBN: 0-870-14460-X
Volume URL: http://www.nber.org/books/youn40-1
Publication Date: 1940
Chapter Title: Relations Among Lenders
Chapter Author: Ralph A. Young
Chapter URL: http://www.nber.org/chapters/c5502
Chapter pages in book: (p. 151 - 160)8
RelationsAmong Lenders
IT is broadly true that in all lines of business common inter-
ests provide grounds for the development of rela-
tions among individuals and firms. In the personal finance
business the special statutes that exempt licensed lenders from
the usury laws, and the possibility of change in the pro-
visions of these statutes, have given a particular impetus to
the development of cooperative relations of the trade associa-
tion type. In order that small loan statutes which will enable
licensed lenders to operate on a profitable basis may be initi-
ated and maintained it is very desirable that the business
present its case to public opinion through some kind of co-
operative association. This need for joint effort; and also the
undeniable public concern about the subject of consumer
indebtedness and the institutions immediately connected with
it, necessitate a certain degree of self-policing which further
encourages the establishment of cooperative relations in the
small loan business. On the other hand, the nature of the
business is such that a high degree of competition has devel-
oped among licensed lenders themselves. Also, they find them-
selves, singly or collectively, in increasing competition with
other kinds of consumer financing agencies.
COOPERATIVE RELATIONS
Cooperative relations among personal finance companies have
arisen primarily from attempts to foster the demand for small
loans, to protect the interests of lenders collectively, and to
supply to individual lenders those services that can best be
'5'152 PERSONAL FINANCE COMPANIES
provided by concerted action. There are three general types
of association, national, state and local in scope, that have
been organized to meet these needs.
The need for some national organization to facilitate co-
operative relations among lenders was recognized fairly early,
doubtless from contacts established at frequent legislative
hearings, and in 1916 the American Association of Small Loan
Brokers was formed for this purpose. The first important
activity of this body was its cooperation with the Russell Sage
Foundation in drafting the Uniform Small Loan Law.' Subse-
quently the name of the organization was changed to Ameri-
can Industrial Lenders Association, and in 1929 the present
name, American Association of Personal Finance Companies,
was adopted. The Association is located in Washington, D. C.,
and is the only national trade association in the personal
finance industry.
The constitution of this group provides that all persons,
firms and corporations extending credit subject to regulation
by small loan laws are eligible to join as "regular members,"
those operating more than one loan office being eligible for
one regular membership for each office. In addition any per-
son, firm or corporation not acceptable as a regular member
but "subscribing to and advocating" the purposes of the Asso-
ciation is eligible for associate membership. About one-third
of all reported licensees are members, the number having
increased from 951 in 1929 to 1,417 in 1938, but members of
the group hold approximately three-quarters of the total vol-
ume of outstanding loans. Only regular members have voting
privileges, each being entitled to one vote for each member-
ship held. Dues, levied on each regular membership, are de-
termined every year by the Board of Directors as a percentage
of average loan balances outstanding during the previous
year. Associate members are charged $10 a year.
'L. N. Robinson and Rölf Nugent, Regutation of the Small Loan Business
(1935) pp. 111-17.RELATIONS AMONG LENDERS 153
The main object of the American Association of Personal
Finance Companies is to elevate the standards of business con-
duct in the trade and to develop a more favorable public
attitude toward licensed lending. The importance of these
functions derives from the history of the small loan business,
which, as has been pointed out, had its genesis in illegal lend-
ing. Even after the advent of legislation the attitude of the
public and the actions of certain lenders were still reminis-
cent, in some ways, of conditions that prevailed formerly.
In order to give direction to its policing functions the Asso-
ciation adopted in• 1931code of ethics setting forth certain
standards of business conduct. The code declares that the
purpose of the industry is to extend loans for constructive and
emergency purposes, and that members of the industry are to
cooperate with authorities responsible for the. enforcement of
small loan laws. In addition, it is required that "members
will explain fully to customers the actual cost, terms and con-
tractual obligations of loan transactions," and "will use writ-
ten instruments as simple, lucid, and unambiguous as circum-
stances will permit." It is further stated that foreclosures are
to be kept at a minimum and that members are to "adhere to
generally accepted standards of business deportment in com-
petitive relations, in advertising, and in their dealings with
the public."
The public relations activities of the Association consist
mainly of issuing pamphlets explaining the operations and
economic functions of the industry, and in publicizing the
point of view of the lenders when their interests are attacked.
The Association also publishes a monthly magazine (Personal
Finance News) covering matters of interest to members, and
in various ways it serves in an advisory capacity on matters of
lending practice.
A Roster of Personal Finance Companies, published annu-
ally by the Association, Contains the name and address of
every known licensee, thus enabling lenders to avail them-154 PERSONAL FINANCE COMPANIES
selves of an indirect kind of collection service: if a customer
moves out of the state a licensee can request a lender in the
region where the borrower is newly settled to collect the ac-
count. Members provide this service for one another without
charge. A list of credit information exchange bureaus, which
is also included in the Roster, enables lenders readily to locate
possible sources of information about loan applicants.
Another activity of the Association is the maintenance of
an advertising committee for information and advice to mem-
bers. This committee also maintains a watch on the advertis-
ing activities of other consumer credit agencies in order to see
that the small loan industry is not adversely affected.
The American Association of Personal Finance Companies
provides in its constitution for a National. Council, the func-
tion of which is to maintain contacts between the national
association and the various state associations. The National
Council consists of the officers and chairmen of the national
association's standing committees, and also representatives of
the state associations. National Councilors keep the Associa-
tion informed on the general condition of the, personal
finance industry in their respective states, and on the impor-
tant policies and actions of their state associations, at the same
time keeping state associations informed as to the policies and
actions of the national association.
In August 1there were 27 voluntary state cooperative
associations of licensed personal finance companies. With the
exception of the Ohio association these do not employ paid
officers, and their function is to carry out, on a state-wide
scale, activities similar to those of the national association.2
The state association represents the licensed lenders at legis-
lative hearings in the event of a proposed reduction in the
maximum legal rate, the national association leaving this re-
sponsibility to the association of the state directly involved.
2Theyare often assisted in their association activities by the paid public
relations workers of the larger chain lenders.RELATIONS AMONG LENDERS 155
The state association also acts to police its members, and
lenders who violate the code of ethics drawn up by the na-
tional association are subjected to considerable pressure, both
from the association and from its individual members.
The third type of cooperative body, the local organization,
is made up of licensed lenders who act together mainly for
the purpose of establishing and maintaining a credit informa-
tion exchange bureau. This is a service of particular impor-
tance to lenders, not only because of its bearing on the main-
tenance of adequate credit standards but also because the
spirit of the Uniform Small Loan Law is that no borrower
should be indebted to personal finance companies at any time
for more than $300. At times the local groups also serve as
collection agencies when the customers of licensees move from
one city to another.
COMPETITIVE RELATIONS3
Of the many forms in which competition expresses itself in
this business, the mOst important from the consumers' view-
point is probably the rate charged for credit services. In the
personal finance business the upper limit to rates that can be
charged by licensees is set by the provisions of the various
state small loan laws. There is a tendency for rates charged by
lenders to approach the legal maximum, but competition
among lenders is reported to bring rates below this level in
some localities and to ease certain other terms of the loan con-
tract.4 For example, in a state with a maximum 31/2 percent
flat rate a company may be found to be charging 3 percent on
For a more detailed discussion of competition in the field of consumer credit,
with particular reference to personal finance, see T. 0. Yntema, "The Market
for Consumer Credit: A Case in lmperfect Competition," American Academy
of Political and Social Science, Annals, vol. 196 (March 1938) pp. 79-85.
4 PennsylvaniaBanking Department Report on Small Loan Companies
(February 1937) states that in 1935, although the Pennsylvania maximum legal
rate was 31/2percentper month on unpaid principal balances, the average
rate charged was 2.89 percent (p. 20).156 PERSONAL FINANCE COMPANIES
the first $100ofeach balance, 2 percent on the second $100,
and 1 percent on the remainder. Price concessions may be
made also on preferred risk loans, the most frequent example
of this type being teacher loans, on which the rate may be a
flat 2 or 21/2percentalthough the legal maximum is 3 or 3½
percent.The general willingness to make price concessions of
this kind is indicative of the lower cost incurred on such
loans, and of the desire of licensees to increase the proportion
of their funds invested in these directions.
Competition may also take the form of concessions on the
non-price conditions of the loan contracts; easier periods of
payment, waiving of security demands, less burdensome col-
lection procedures and other inducements may be adopted.
The speed with which loans are made, and the confidential
character of the lending arrangements, are often cited by com-
panies as differential advantages that borrowers should take
into consideration in choosing a lender.
Another form of competition is the amount of money that
will be advanced to any one borrower. In general, the larger
the loan carried by any given individual the greater the
chance of default, unless the borrower's income is relatively
high, but some lenders are willing to take the additional risk
in order to increase their loan volume, and thus they will
offer a larger loan, relative to the borrower's income,, than
will other lenders. Other less direct forms of competitive ef-
fort manifest themselves in advertising practices, including
efforts to gain the most convenient and attractive location for
loan offices.
Competition between personal finance companies and
other similar agencies, such as industrial banking companies,
the personal loan departments of commercial banks, and sales
finance companies, is becoming increasingly important. In
most states commercial banks and industrial banking com-
panies are allowed to make larger loans than personal finance
companies, but they have actively entered also into the lend-RELATIONS AMONG LENDERS 157
ing of amounts up to $300. The credit services extended by
sales finance companies are also in many ways comparable
with those offered by the personal finance companies, al-
though the form of the borrower-lender relationship may
tend to hide the similarity.
In all agencies engaged in consumer lending the trend of
development seems to be toward greater diversification of
credit activities. Thus a company making cash loans may in
addition encourage borrowing to finance a commodity pur-
chase, or may operate a sales finance affiliate or subsidiary; a
sales finance company, through special offices or affiliated
companies, may actively engage in the small cash loan busi-
ness; and comniercial banks are likely, if they set up a per-
sonal loan department, to diversify their business as far as
possible. As a result there is a complicated competitive situa-
tion among the agencies supplying consumer credit: compa-
nies that might operate in fairly distinct markets, if it were
not for this general diversification of activities, find them-
selves offering, in effect, the same services to substantially the
same market.
Finally, where maximum legal rates are low there is a cer-
tain amount of competition between licensed and unlicensed
lenders—particularly in regard to middle-size loans, since the
licensed lenders cannot afford to grant many smaller loans
and the high rates of the unlicensed lenders cannot attract
many borrowers of larger sums. And in such states the li-
censed lenders may also have to face the competition of
licensed lenders in neighboring states where the laws permit
higher rates; after the rate reduction in New Jersey, for ex-
ample, many lenders, as was mentioned above, moved to
nearby towns in Pennsylvania and continued to make loans to
New Jersey customers in competition with the small loan
companies that had remained in that state.
Certain characteristics of the personal finance business
doubtless serve to limit the degree of competition prevailing158 PERSONALFINANCE COMPANIES
in this field. The loan office itself is distinctly local in its
operations, serving a necessarily limited market; it is impos-
sible for a large number of licensees to operate in one locality
and thus create any high degree of competition. The number
of offices in a single community is also influenced in certain
states by small loan legislation that instructs supervisory au-
thorities to limit the granting of licenses to suit the "con-
venience and advantage of the community."
Itisquestionable, however, whether rate competition
among many offices in a community would be as likely to lead
to lower rates as would competition among only a few offices.
If the number of offices in a community is small, and hence
the average size of office relatively large, the resultant econ-
omies of operation may stimulate a more severe rate competi-
tion than would be the case if offices .were of relatively small
size. In some states the legal limitation as to number of offices
in a community makes it possible for the average size of office
to increase rapidly without recourse to aggressive competition.
It is not possible, however, to make statements of general
validity on these points. The form and extent of competition,
or the lack of it, are determined by the special circumstances
attending specific situations. The effects of rate competition
depend on the amount of the rate cut, the extent to which the
cuts are met by other lending agencies, the amount of adver-
tising and general sales promotion effort which accompany
the rate change, and the period of time over which the lower
rates are maintained. From the point of view of business
profits the desirability of rate cutting depends on the resultant
changes in total receipts and in costs of operation; and the
nature of the market is such that a short-run rise in total re-
ceipts from increased borrower demands at lower rates is not
to be expected. In certain circumstances, such as a situation
of impending legislative action aimed at further regulation of
the small loan business, Tate cuts might be considered advan-RELATIONS AMONG LENDERS 159
tageous even if they did not result in an increase in total
business receipts.
The character of the borrower-lender relation is such that
small changes in rates are unlikely to cause borrowers to shift
from one lender to another,5 although a substantial rate cut
may have this effect, increasing the volume of business done
by the rate cutting firm at the expense of its competitors. It
might be noted that the shifting of borrowers from one lender
to another does not necessarily wait upon the normal paying
out of a given borrower's account over the contractual period.
There is apparently a good deal of paying off of loans from
one lender by means of funds borrowed from another lender,
but there is no evidence to indicate the extent of this practice.
The method of quoting rates on small loans often confuses
borrowers and renders difficult a comparison of terms offered
by different licensed lenders, particularly in those few states
where it is permissible for small loan companies to charge
fees. Borrowers have even greater difficulty in comparing
terms offered by different types of consumer credit agencies,
and competition would doubtless be increased considerably if
all agencies quoted terms on auniformbasis, either in dollars
or in percent.
A final aspect of the competitive situation in the small loan
market is the interchange of credit information among vari-
ous lenders. Undoubtedly, both from the social point of view
and from that of the individual lender, a complete inter-
change of information on the instalment-debt position and
record of the individual borrower is greatly to be desired.
Under such conditions the costs of investigation and the risks
of lending would be reduced substantially, and the likelihood
of any given borrower receiving a total of credits in excess of
his capacity to pay, thus involving himself in severe financial
straits, would largely be obviated. The possession of credit in-
formation, however, is sometimes viewed by individual lend-
See T. 0. Yntema, cit., p. 83.i6o PERSONAL FINANCE COMPANIES
ers and by groups as an important asset, not to be shared with
competitors. In fact, personal finance companies publicize
widely the private or confidential treatment they accord all
loan applications, implying that borrowings will not be dis-
closed to any agency, employer or other person who might
use the information to the borrower's detriment, at least in
the latter's judgment. Consequently the growth of an ade-
quate interchange of credit information between personal
finance companies and other agencies has been inhibited,
though such interchange has developed to a certain degree
among personal finance companies themselves. Moreover, the
intensification of competition among various types of con-
sumer credit agencies during recent years has tended to the
breakdown of previously well-established credit information
agencies. The situation varies, of course, in different com-
munities; some have very complete agencies while others are
almost entirely lacking in such facilities.

Personal Finance Companies and Their Credit Practices

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