Regulation of loan sharks and the interest rates they charge are the focus of a new member's bill about to be put into Parliament's ballot by Labour MP Charles Chauvel.The most obvious question is how does the Reserve Bank governor know what the maximum interest rate should be? How could he ever decide what the rate should be given that, I assume, he isn't going to pick the market rate. What makes him better at setting prices than the market?
The Credit Reforms (Responsible Lending) Bill proposes the Reserve Bank governor would set the maximum interest rate lenders could charge, while lenders would be required to assess the borrower's ability to repay the loan.
Also I assume that the Reserve Bank governor will be setting a rate that is less than the market rate, there seems little point in him setting it above, so how will he deal with the excess demand for loans that will arise. What mechanisms will be available for the non-price allocation of loans? And why are these non-price mechanisms more welfare enhancing than the price mechanism? In addition there will be people who want loans but can't get them, so what will they do?
Another question is why are the interest rates on loans so high? The market looks pretty competitive so these rates may well reflect the actual cost of providing loans. For a start what is the default rate on these loans? A high interest rate may just reflect, in part, a high default rate. Also as most loans are for a small amount over a short time period the cost of administrating the loan as a percentage of the value of the loan will be very high. Again the high interest rate may reflect actual costs of production.
The high administration costs of these loans may well explain why other lenders, such as banks, don't offer this service. So without "loan sharks" this service may not be available at all.
Chauvel also wants " lenders would be required to assess the borrower's ability to repay the loan". Don't all lenders do this already? After all it is in their own best interests to do so. They want the loan repaid, so making sure that the person can repay is simply good business sense.
You do at times see the argument that people "have to borrow" to live and thus high interest are are immoral and so a cap is justified. But this seems to be a case where, if this is true, then a cap on interest rates isn't the answer, a better plan would be financial or budget advice or a revamp of the welfare system so peoples income is such that borrowing is not "needed".
All in all I don't seen any economic sense in the proposed bill.
Update: I see I'm behind the times on this one. Kiwblog comments here and Matt Nolan comments here.
Update 2: BK Drinkwater has Questions About The Loan-Shark Bill In The Ballot and has now been Gathering My Thoughts On Loan-Sharkery: Information and Gathering My Thoughts On Loan-Sharkery: Interest Caps and Gathering My Thoughts On Loan-Sharkery: High Interest Rates and Gathering My Thoughts On Loan-Sharkery: Black Markets and Gathering My Thoughts On Loan-Sharkery: Other Ideas.