Final answer:
Payday loan companies can operate successfully by including the likelihood of loan defaults in their financial calculations, with the understanding that some customers may not be fully aware of the costs involved. These businesses depend on high-interest rates and the risk assessment that some loans will not be fully repaid.
Step-by-step explanation:
Payday loan businesses remain viable because they calculate the risk of loan default into their business model. A well-run bank understands that a portion of loans may not be repaid and includes this as a factor when assessing their expected yearly expenses. Despite meticulous planning, banks can endure financial distress if the actual number of loan defaults exceeds projections, particularly during economic downturns.
For instance, if there's a surge in defaults causing a bank's loan values to plummet from $5 million to $3 million, it could lead to a bank's assets diminishing and ultimately a negative net worth. Payday loans often involve high interest rates and short repayment terms, banking on the notion that some borrowers might not fully comprehend the substantial costs they incur, thus enabling these businesses to profit in spite of the high default rates.
Payday loan businesses can stay in business because they account for the possibility that some customers will default on their loans. Banks factor in this risk when calculating their expenses and the value of their loans on their balance sheets. They anticipate a certain percentage of loans not being repaid, and therefore, plan for these losses. Even if a bank expects defaults, it can still suffer if the number of defaults exceeds what was anticipated.