A recent report issued by a group of
researchers at Otago University finds that some of the less well-off members of
our society are at times paying as much as a 400 percent interest on loans
taken from money-lenders. The report calls for, among other changes, a cap of
48 percent on any such loans.
Simon Bridges, the Minister for Consumer
Affairs has continued the slow progress since 2007 toward a law change to
ensure responsible lending, but his proposals exclude an interest rate cap.
The poor resort to loans from
moneylenders at very high rates of interest because that is their only
recourse. Given that they are considered not credit-worthy and often have no
collateral to pledge, it is difficult for them to get loans from commercial
banks. And banks and second-tier lenders are often reluctant to lend to those
on welfare or dependent on part-time work, so they have a hard time borrowing,
even it is for the purpose of starting a small business. This means if someone
who is poor needs a loan, sometimes at short notice, then the only option is to
turn to money-lenders. This is true of the poor not only in New Zealand but all
over the world.
One potential argument against capping
interest rates is that the interest rate on a loan is a price. It is what the
money-lender earns by making the loan. Therefore putting an artificial cap on
this interest rate might actually reduce the pool of money available for borrowing.
However, it seems to us that even if we cap that rate at 48 percent it provides
a “high enough” return to the moneylender, at least higher than what could be
earned from alternative investments. Furthermore, available evidence suggests
that the amount of loans forthcoming from money-lenders is not very price
responsive and that capping interest rates does not seem to significantly
reduce the amount of money available for borrowing. It also appears that
commercial banks are prepared to develop loan products for small entrepreneurs
at interest rates close to cap rate, thus increasing the available pool of
credit funds.
Under current conditions, that act of
taking out a loan at 400 percent may not be “irrational”. If a poor family
borrows money to finance an important family or religious event then it is most
likely that their calculations suggest that the price of not funding the event exceeds the cost of borrowing the money. Too frequently though, the money is borrowed
to pay for electricity, or food, or car repairs so the worker in the family can
get to and from their job. As Abhijit Banerji and Esther Duflo of the
Massachusetts Institute of Technology argue in a recent influential book “Poor
Economics” the weight of the evidence suggests that when it comes to matters of
money, the poor are no less rational than the more affluent.
The
problem is three-fold. First, to the extent that some of this borrowing is
going to finance social events, there may be a case for tackling entrenched
social norms like hundreds of guests at weddings or feasts at funerals. There
is also a need for financial literacy, so the full price of the debt and the
burden are clearly understood. Most of all, there is the need for another option. For consumers on low incomes, access to
small loans to cover emergencies or to smooth out the costs of large expenses
could be considered an essential financial service.
This is exactly why
all over the world we have seen the rise of microfinance institutions which
provide loans to the poor. In most countries where microfinance
organizations are active, they have made substantial contributions towards
reducing poverty. As the Otago
University research states: “A critical and complementary factor supported by
other research and informants is ensuring an adequate supply of affordable
micro-finance through mainstream banks, credit unions and other community
lenders.”
When the consumer has no choice, 400 percent interest becomes the norm.
And it turns out that even in developed countries there are substantial numbers
turning to the money-lenders because they are, for whatever reason, excluded
from accessing mainstream bank loans.
The reach of microfinance organisations in New Zealand at this point
seems limited. Nga Tangata Microfinance
was introduced by Child Poverty Action Group, NZ Federation of Family Budgeting
Services and NZ Council of Christian Social Services in 2011. It is accredited
by Australia’s Good Shepherd Microfinance as a No Interest Loan Scheme (NILS)
provider, with loan funds for asset-building and family development provided by
Kiwibank.
Safe, fair, affordable alternatives to predatory lenders are necessary
in a low-wage society like New Zealand. Such microfinance loans also provide
the opportunity for borrowers to develop financial literacy, build a positive
financial history, and ultimately to access credit when needed from mainstream
lenders. Until such alternatives are available, money-lenders will continue to
legally constrain poor families in poverty.
A two-fold
response to the problem of predatory lenders would be to expand the scope of
such No Interest Loan Schemes, and include capping of interest rates among the
Responsible Lending amendments.
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