8% weekly interest rates: What’s going on

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:

  1. 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),
  2. 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.

  • There’s actually been research done – somewhere, I don’t have a link – that argued from actual data that people who use these short-term loan facilities are happier than those people who were denied access.

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  • Steve Pierson

    it should at least be the law that all loans must have their interest rates expressed in % per annum, and that the total repayments for any loan should be stated to the borrower before a loan is taken out.

  • “There’s actually been research done – somewhere, I don’t have a link – that argued from actual data that people who use these short-term loan facilities are happier than those people who were denied access.”

    Interesting – it does make sense.

    “it should at least be the law that all loans must have their interest rates expressed in % per annum, and that the total repayments for any loan should be stated to the borrower before a loan is taken out.”

    I agree – information should be more transparent. As I said “The real problem stems from information and education”.

  • Kimble

    It is the law.

    http://www.comcom.govt.nz//Publications/ContentFiles/Documents/382356_1.pdf

    You must disclose the annual interet rate and say how much the interest is expected to be over the term of the loan.

  • Kimble
  • Kimble

    From my own experience, even when people are presented with black and white evidence of the interest rate and how much it will cost them, they only see what they are wanting to spend the money on.

    If they dont care, why should we?

  • “It is the law.”

    Very good. However, the question then is – is this being enforced.

    “From my own experience, even when people are presented with black and white evidence of the interest rate and how much it will cost them, they only see what they are wanting to spend the money on.

    If they dont care, why should we?”

    Indeed – as long as they understand the private cost of what they are doing there is no need to stop it. The only role government should have is to improve transparency so people can make these decisions.

  • When I read the article I had much the same reaction, education looks like the best answer. The one question I would ask is what is the default rate for these loans? Are the high rates of interest reflecting, in part, a high risk factor?

  • “Are the high rates of interest reflecting, in part, a high risk factor?”

    That would be my suspicion – in the Herald article (which I can’t find) one person is defending these loans, on the basis that their credit history is so bad they can’t get loans anywhere else.

    However, there may be some punitive element to the current loans (as I doubt that the default rate, and the associated adverse selection risk, is high enough to justify 8-10% per week) – but that only survives in the face of poor information and education on the borrowers side.

  • oldhippy

    Matt, the Herald article you’re looking for is actually from the Dom Post here.

    If you look at the commercial reality of providing these loans, the interest rate has to be high because they are usually low amounts, borrowed for short terms, from high-demand customers. For example a $50 loan over 10 weeks (the example in the Dom Post article) will generate $40 of interest which has to cover a paperwork session to set up the loan and accepting weekly cash payments for 10 weeks, as well as the expense of chasing late payments and the risk of not recovering the money at all.

    No bank is going to offer $50 loans like this, their overheads are too high. They will want you to set up an overdraft or get a credit card, for which you need a good credit rating.

    Goodness knows there is plenty of competition for these loans, and some are charging even higher rates (one online one I looked at charges up to 15% a week). The Standard says there are six of these places in Porirua. You would think if it could be done more cheaply someone would be doing it.

  • “Matt, the Herald article you’re looking for is actually from the Dom Post here.”

    That would explain why I had so much difficulty finding it 😉

    “Goodness knows there is plenty of competition for these loans, and some are charging even higher rates (one online one I looked at charges up to 15% a week). The Standard says there are six of these places in Porirua. You would think if it could be done more cheaply someone would be doing it.”

    Incredibly good point!

  • The requirement to disclose the annualised rate doesn’t mean they have to put it on promotional materials.

    A law requiring this would mean that they need to say 5470% per year in letters at least as big as the 8% per week. If this was done, surely borrowing at these rates would go down significantly. More people are doing it out of ignorance than out of choice.

    I say this as someone who is opposed to most regulation.

    A cap on interest rates is obviously silly though. It would be worse than just some people that need to borrow not being able to borrow because criminal gangs would enter the lending market.

  • “The requirement to disclose the annualised rate doesn’t mean they have to put it on promotional materials.”

    Ahhh very interesting.

    “A law requiring this would mean that they need to say 5470% per year in letters at least as big as the 8% per week. If this was done, surely borrowing at these rates would go down significantly.”

    If that is the case, then there is definitely a case for better information to be legislated.

    “I say this as someone who is opposed to most regulation.”

    Improving the transparency of information is the one place where regulation makes sense – in other cases it is a poor second cousin to other instruments (at least in my view 🙂 )

    “It would be worse than just some people that need to borrow not being able to borrow because criminal gangs would enter the lending market.”

    I’m not sure – people only borrow from the gangs because they want the credit. I think the gang case is actually better than the case when they can’t get any credit – although both are far worse than the case with no cap

  • Kimble

    “If this was done, surely borrowing at these rates would go down significantly.”

    It just means they wouldnt advertise it.

  • Kimble

    And that would actually be worse. Because there wouldnt be any advertising of the interest rate, so there would be no public disclosure of the tiny “pw”.

    We may think the “pw” is inadequate, but we shouldnt lose sight of it being better than nothing. The last thing we want to do is create a law that will make things worse.

    That would make us no better than the politicians!

  • “It just means they wouldnt advertise it.”

    Indeed that would be a constraining facotr, but it would not necessarily be the case.

    The purpose of the advert is to get more people in the door and getting loans – a transparent advert may still do that to such a degree as it is worthwhile.

    However, it is a good point that trying to enforce certain requirements on adverts may lead to “less” information – the goal should always be to increase the information available and/or the ease of disseminating the information.

    Ultimately, I think as long as the contracts have to be transparent, and we make sure that people understand what they are signing, there isn’t an issue. If those things don’t hold – then that is what we need to fix. A misleading advert is not a problem, if it doesn’t influence peoples decisions.