Limiting Payday Loans Is Tricky
Pity the government that tries to regulate payday lending, those short-dated personal loans that come with exorbitant interest rates. Overseeing an industry that caters to society's most vulnerable is always a game of unintended consequences. Outlaw payday loans altogether, and you choke off credit to the low-paid when they're at their most financially desperate.
Today, the U.K. is taking another step down this tightrope by introducing new restrictions on the market. The rules cap interest rates so that no borrower pays back more than twice the amount borrowed. Daily charges can't exceed 0.8 percent of the total, and there's a limit on default fees. Those seem like sensible restrictions, added to the U.K.'s existing ban on rolling over such loans more than twice -- to prevent a small initial loan snowballing into a huge debt.
The U.S. is likewise considering a cap on payday-loan interest rates. The Consumer Finance Protection Bureau has suggested a 36 percent cap on loans to military personnel. Some states have their own limits on rates, but don't apply them to payday loans, or they allow some lenders to use credit-card exemptions to avoid the rules.
The problem with rate caps is that they can drive some lenders out of business or, worse, send them onto the black market. Martin Wheatley, the U.K. Financial Conduct Authority's chief executive officer, told a reporter that, in a year, there might be, at most, only about a dozen payday lenders left in Britain.
Yet people often need these loans. Yes, it's repugnant that a company offering a needy borrower 300 pounds ($475) for 45 days can charge at an interest rate that would amount to more than 2,700 percent annually (if rollovers didn't prevent the loans from lasting more than 90 days). But if someone is desperate enough to accept the terms, it's preferable that they use a regulated company rather than a gangster in the local pub.
Setting caps at a sufficiently high level can avoid stifling the flow of credit to those in need, however, as a European Commission study found. It's when caps are set too low that the riskiest borrowers can't clear the threshold to get a loan.
The study also found that interest-rate caps on payday lenders don't restrict access to credit elsewhere in the economy. And there's no conclusive evidence that the caps force more borrowers to take illegal loans.
Other countries seem to be doing fine with interest-rate caps. France has strict rules, outlawing usury, which is defined as any amount that's more than one-third higher than the average for similar loans. Germany's criminal code takes a more moral stance, describing usury in terms of exploitation of people for excessive profit; its courts have interpreted that to sanction lenders charging more than double the average rate.
France and Germany have two of the region's three biggest consumer credit markets -- the commission's study ranks U.K. third -- which suggests that setting boundaries doesn't necessarily drive lending underground. Payday lenders meet a need; how they do so can and should be regulated, without hurting the poor.
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