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.