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Zer Netmouse
February 3rd, 2009
07:12 pm

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Do You Believe in Usury?

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From:nicegeek
Date:February 4th, 2009 02:57 am (UTC)
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"I have to admit, I wonder if there's not an interest rate that actually raises the chance that someone will default on a loan, i.e. "take the money and run" rather than pay such an expensive loan back."

There probably is, but that actually argues against the need for a cap, since charging too high a rate would be self-defeating.

"But, seriously, you don't have a problem with it if someone is charging 45-75% interest on a loan?"

The counter-question is "Why is the borrower considering taking a loan at that high a rate?" If it's because a lender is charging them a higher rate than they could get elsewhere, a public information campaign would be a more appropriate solution to teach people to shop around. If it's because the administrative costs and default risk of the loan actually make that high a rate necessary, then the alternative is for the person to get no loan. While that might be better in some cases, there are numerous examples, of such loans doing a lot of good, especially in third world countries.

Take the case of CompartamosBanco, a lending institution in Mexico. It charges rates in that range and higher. However, it makes tiny loans to people with no credit history (and often no bank accounts) in remote villages, so that they can start businesses. If it was constrained to interest rates such as we see in the U.S., these people would never get loans at all, save by the grace of charity. But because it can lend profitably, CompartamosBanco lets them get their businesses started, and other lenders are moving in, causing competition to start to push the rates down.

There was a similar surge of microlending a while ago in South Africa, but the government capped rates and killed the industry.

From the research paper's conclusion:

"The interest rate ceiling produces a series of adverse effects. They cause charges to drift up to the ceiling and they also encourage illegal lending. Instead of regulating interest rates a more effective approach to ensure that the rates charged by micro lenders are appropriate is to encourage competition. This will spur innovation aimed at reducing the risks and costs associated with micro lending."
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From:netmouse
Date:February 4th, 2009 03:20 am (UTC)
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Huh. The South African cap was defined as a multiple of their prime rate according to the paper you reference. An interest cap defined as "ten times the prime rate" is tremendously sensitive to the order of the prime rate. If the prime rate is 1 percent, the cap is 10%, but if the prime rate is 10% the cap is 100%. The paper argues the micro-loan short term (0 - 6 month) lenders needed a 30% interest rate in order to be profitable, but they do not discuss what the actual interest rate cap was during that time.

There is a reason why the "group" microloan system in Bangladesh won the Nobel prize. There are other ways to reduce risk apart from charging higher interest rates.
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