8% weekly interest rates: What’s going on
Posted September 4, 2008on:
Following the “revelation” that a loan shark in Porirua was charging 8% interest per week on loans, the government has offered to do nothing. Blogs on the left hand side of the spectrum were irritated by this, as they feel that people are being taken advantage of (the Standard) (Tumeke) (Frontline – prior to this incident). Lets investigate the issue.
Now I am not disputing the fact that people are, in some sense, “being taken advantage of”, however I do disagree with the solution that the other blogs follow – setting a cap on interest rates. In this sense I am in agreement with government policy.
Capping the interest rate is not the way to go – as the interest rate is the price on credit. This is obvious from the Herald article (which I can’t find – if anyone can could they put the link in comments) where someone is quoted as saying that they can take out a short loan for a couple of weeks when they really need it – a service that is otherwise not available. Setting a cap would prevent these transactions from occurring while simultaneously increasing the quantity of them demanded – leading to a shortage of credit transactions (*).
The real problem stems from information and education. On the information side, people are definitely being taken advantage of – as shown by the Stuff article:
The brightly coloured advertising signs, which can be seen from outside the Work and Income office across the road in Porirua, make the “per week” disclosure as “PW” in much smaller type than the “Interest only 8%”.
If the borrower does not realise how the interest compares to other financial institutions – they may borrow when it is not in their best interest. In this case the advert should be classed as misleading advertising.
Even if the borrower did realise what it said – they may not understand it. This is illustrated in the Hearld article by the person that isn’t worried about paying off the debt – as they can just roll it over (borrowing to repay the debt, again at 8%pw). The solution to this would be to educate people. If we taught people at school to be financially literate – we would not have this problem. Trying to regulate the market by setting an interest rate cap to account for insufficient education is not the best solution.
But what about when people have to borrow to live!
According to John Minto there are many occasions when people have to borrow to live, and therefore the high interest rates being charged are immoral and we should cap them (*). To tell you the truth this type of argument makes me a little sick.
On the surface of it, this sounds like a caring claim – people “need” to borrow, so we shouldn’t be taking advantage of them. However, there are two problems this ignores:
- The unemployment benefit (and corresponding employment opportunities) are not so low that people “need” to borrow from loan sharks to “survive” – if that was the case I would be all for increasing the unemployment benefit to a level where people can “survive” (of course our definitions of survival and need may differ),
- If they did need to borrow, then setting a cap on interest rates would mean that some people that need to borrow can’t borrow – while the lucky people do get to borrow, but at a lower interest rate.
This is one of those cases where people want a lower interest rate to “help” people – but in a situation where people are a high risk of defaulting, setting an interest rate cap will merely lead to less loans and people missing out.
As long as we can improve the transparency of information surrounding loans, and increase financial literacy, there is no need to fluff around with price regulation in financial markets.