Wednesday, 20 May 2009

Regulation of loan sharks (updated x2)

From the TV3 news website I learn that,
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 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.
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?

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.


matt b said...

Christ this idea is seriously misguided. This has unintended consequences writ large. Its already a fairly black market type business, I doubt this bill will have anything like the effect Chauvel thinks it will.

For one, pricing can move to a place the bill doesn't regulate. Like raising late payment fees or adding a brokerage fee or a surcharge for x,y and z.

Or pricing can be non-pecuniary. Less patience for late repayment and more strong arming.

Or, if borrowers are looking at a shortage in the regulated market, as you'd expect, then they will go underground - perhaps to the same shark running a cash business off the books.

Anonymous said...

Loan sharks do assess whether people can repay, but many people get bailed out by WINZ and the loan sharks know this so lend to beneficiaries who can't pay it back and they set up shop next to the WINZ offices.

What is needed is for WINZ to stop bailing people out and for loan sharks to be prevented from selling loans in the near vicinity. Maybe also rules around forcing loan sharks to more quickly write off loans when they can't be repaid, and this would better incentivise them to choose who they lend to more carefully.

Richard McGrath said...

Loan sharks have a role to play, lending money to high-risk customers. Matt B is quite right; Chauvel hasn't thought this through.