"Capping interest rates is not the way to stop irresponsible lending to people who can't afford the loan" microcredit activist Faisal Rahman tells the Guardian.
In an Interview to the Guardian Faisal Rahman argues that continental anti-usury legislation is no way to cope with predatory lending. Instead he favours penal sanctions. This kind of interview is in line with statements of ADIE in France which also argued against rate ceilings. Within ECRC these groups work together. It is therefore crucial that the seven principles of responsible credit where usury ceilings play an important role are taken seriously.
Penal sanctions alone have never stopped usury. In Germany not a single bank has been condemned for usury since WW II although the penal paragraph has the same wording as the paragraph in the Civil code. Where ever social interests in long-term relations meet money interest of those who only want to maximise their return, then minimum wages, rent regulation and usury ceilings are necessary to prevent such capital interest from exploiting social weakness.
The EuSoCo project which is also part of ECRC activities brings together legal scholars from many countries to discuss these common elements of credit, housing and labour relations. We hope that the ethical investment movement is not only a movement where wealthy people get a kind of absolution by claiming that their money making is at the same time ethical and social only because those who invest refrain from some nasty elements of the money economy. All investors live on the work of the borrowers. They should directly and empirically study the conditions under which borrowers are still able to render their investments profitable. Usuriously high interest rates are not such conditions which allow people with low productivity to produce the highest yields for wealthy people who even call their form of exploitation ethical. Access to credit is not what we want. We ask for access to life productive credit for people.
Below are the guardian article from ECRC partner and columnist Faisal Rahman and a comment from ECRC founding UK member Debt on Our Doorstep - questioning its analysis.
Lenders who deal in misery should face a jail sentence
Capping interest rates is not the way to stop irresponsible lending to people who can't afford the loan. (By Faisel Rahman, The Guardian, Wednesday 23 September 2009)
Today, I rescheduled a perfectly legal loan charging 750% APR. It started off as a short-term loan, then a second was offered a few months in – and, before the person knew it, he'd paid twice the value of what he'd borrowed, and still had capital outstanding.
The company that made the loan is part of an industry serving nearly 4 million people across the country, and I know I'm not alone in wondering how companies like this actually exist in the UK. I find it shocking that many are even profiting in these difficult times.
Calling for an interest rate cap might seem to be an answer, and last month campaigners demanded a limit of around 10% on credit charges. A usury law, some argued, would do for personal finance what the Jubilee debt campaign did for third world debt. However, I think this is dangerously simplistic and fundamentally misunderstands the real experience of the many millions of people who borrow at usurious rates.
There are three reasons why doorstep lenders, payday lenders and pawnshops get away with charging anything from 100%-20,000% for short-term loans: collecting the data on people with thin credit files is expensive and laborious; managing defaults can be expensive; and there isn't enough competition to bring the price down.
People using these products don't do so because they are stupid or are unaware of the rates being charged. They do so because they're accessible and flexible. Regulation of collections is relatively lax, but the majority are not people wielding baseball bats. Repayments are small, affordable, and the amount collected fits the client's income patterns.
Setting an interest rate cap could put the legal doorstep lenders and payday lenders out of business. That might seem to be a good thing for those of us who don't need to use them, but some credit unions already charge around 30%, and my own not-for-profit charges nearly 40% to be sustainable. There's no reason to believe that banks will step in to fill the gap with lower interest rates.
If you don't enjoy the luxury of being able to save, the only option left to pay for a school uniform, or fix a broken fridge, would be borrowing from someone who isn't bound by the law – a loan shark. And the rate is inconsequential when missing a payment probably means a broken leg.
The problem I see all the time with our clients is not necessarily the rate or price of the loan, but the amount and number of debts they can end up with. One payday loan is manageable for a short period of time, but four rolled over many times? Clearly, there's over-borrowing by some, but it's matched, if not exceeded, by over-lending.
There are two related issues here: the supply of credit, and responsibility in lending. We need more credit in the right places and better lending practices. An interest rate cap will merely reduce the amount of credit available, while doing nothing to address how loans are made.
Evidence of the income and expenditure of every person to whom a loan is made would be a start. And jail terms for "irresponsible lending" – to someone who can't afford the loan you've made – would focus lenders' minds.
They say that if they lend irresponsibly they lose money, but people are driven to court and suffer stress, anxiety and even eviction. Responsibility is not shared. I would love one of my clients threatened with bankruptcy, for a loan they could never afford, to actually put the chief executive of RBS or Barclays in the dock with a counter-claim.
Let's make irresponsible lending the enemy, and help to create more competition to put the extortionate lenders out of business.
Faisel Rahman is director of financial inclusion social enterprise Fair Finance.
Comments of the post by Debt on our Doorstep (23 Sept 2009)
Faisel makes a poor argument against interest rate ceilings. In fact there is no reason why price ceilings would not be an effective means of ensuring people aren't ripped off in the uncompetitive credit markets he describes. That's basic economics. Uncompetitive markets allow lenders to mark up prices over and above where they would be under normal market conditions. They therefore make excess profits. Caps can perform the function of reducing prices to the level where normal profits would be made - not to the point of preventing profit altogether.
The question therefore is where to put the cap, not whether it could work in principle. Of course, the credit market is complicated because the APR measurement of price is subject to vagaries. It is skewed against short term lending. The shorter the term of the loan, the higher the APR. But this doesnt disguise the fact that the poorest pay the most or that, as the Competition Commission found over two years ago, excess profits are being made.
So let's focus on a different measurement of price - the total charge for credit. Provident Financial, the UK's largest door to door lender with over 50% of the market, charge about £65 for every £100 borrowed. Thats a Total Charge for Credit (TCC) of 65%. Payday lenders typically charge between 15% and 33% total charge for credit on the first month, but this figure doubles each time the loan is rolled over. As for credit unions and agencies like Faisel's own Fair Finance in Tower Hamlets, well APRs of 30% to 40% may sound grim, but the total charge for credit on these loans lies between just 8% and 10%. Faisel seems to have panicked that a cap could put him, as well as Provident, under pressure to reduce prices. But he just needs to forget APRs and support a cap on the Total Charge for Credit at somewhere around 20%. That would deliver real savings to low income borrowers and wouldn't put anyone out of business, but it would ensure that Provident were no longer able to benefit from a lack of effective price competition and it would limit payday lender irresponsibility.
Of course, there are alternatives to capping - for example by encouraging greater competition in the first place. But since the financial crisis has hit this is likely to take anything between four and ten years to happen. And it's already been 6 years since we first highlighted the lack of effective price competition in the door to door lending market. Just because people are poor doesn't mean they should be forced to pay unfair prices for a decade!
Come on Faisel, lets not divide those that are on the side of low income borrowers – we know where the real problems lie. A united campaign for a cap now could make all the difference!