[Free Speech] Lowering the Legal Maximum Interest Rate... Does It Really Help Working-Class Finance?

Financial Market Contraction Could Force Loan Sharks Out of Business

Low-credit borrowers in urgent need of cash pushed into a blind spot

Hoping to prevent excessive profiteering by lending companies and financial institutions and to ease the interest burden on vulnerable groups, the government and the ruling party decided at a policy consultation on November 16, 2020, to lower the current statutory maximum interest rate from 24% per year to 20% per year. Kim Tae-nyeon, floor leader of the Democratic Party, criticized the current maximum interest rate, saying that keeping it at 24% was an anachronism, and emphasized the need for policy change. However, if this interest-rate cut policy is implemented, it is expected to bring about serious side effects, contrary to the government’s expectations.

First, lowering the statutory maximum interest rate would instead shrink the financial market. If it is regulated at 20% per year, it is predicted that about 6,000 lending companies will no longer be able to serve borrowers who had been receiving loans at rates above 20%, leading to business difficulties and possible suspension of operations. Since most of the borrowers who had been borrowing at rates above 20% are low-credit individuals with credit ratings of 8 to 10, they will face an even more difficult situation in obtaining loans than when the previous 24% annual cap was in place. As a result, borrowers who can no longer obtain loans through existing channels will instead seek loans under even worse conditions. The lower the maximum interest rate falls, the more ordinary people in urgent need of cash are driven into a blind spot.

In the past, when the statutory maximum interest rate was lowered from 27.9% per year to 24%, the number of people pushed into illegal private lending was estimated at around 50,000, higher than the government had predicted. This time, if the 20% cap is applied, it is projected that about 600,000 people—roughly 12 times more than before—will flow into that market. In other words, cutting the maximum interest rate, contrary to its intention of helping low-income borrowers, will instead leave them in an even more difficult situation. Aware of the possibility of such side effects, the government announced supplementary measures such as expanding policy microfinance programs like Sunshine Loans and strengthening debtor relief programs such as the personal rehabilitation system, but such measures will be insufficient to prevent the expected side effects.

In other words, prices artificially lowered by a policy of cutting the statutory maximum interest rate constrain the rational interactions of market participants and cannot perform the function of conveying economic information. Because prices distorted by price controls fail to reflect the relative value of resources, they cannot provide market participants with a standard for resource scarcity. Ultimately, unlike the law of supply and demand, the government’s artificial control of interest rates has the inherent limitation of being unable to present proper direction to economic actors.

As such, forced interest-rate cuts clearly produce side effects. By contrast, the claim that lower interest rates expand liquidity and stimulate investment has not been borne out in actual markets when viewed in light of past cases. Despite these concerning side effects, the government’s interest-rate controls will ultimately inflict even greater harm on ordinary people. It is better not to block opportunities for ordinary people in urgent need of funds to borrow money. Therefore, the government should carefully reconsider this and withdraw the policy of lowering the statutory maximum interest rate.

Shingyu Kim, Intern Researcher, Center for Free Enterprise (CFE)

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Original title: [자유발언대] 법정 최고금리 인하 ... 서민금융 구제한다고?

Author: Sin-gyu Kim

Date: 2020-12-09

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=free_opinion&pn=13&idx=23354