The invisible effects of introducing an APR cap

It seems that the amendments to the Consumer Credit Act will be approved by parliament. According to the advocates of these amendments, they will benefit the consumer, protecting him from some allegedly bad practices of credit institutions. However, politicians often pay attention only to the visible effects that a law or regulation creates, without thinking about the invisible results. In this brief commentary, we will indicate what the consequences of introducing an interest rate cap (in this case, the annual percentage rate of charge - APR) on loans granted will be - one of the changes provided for by the law.

Although the amendments are planned to apply to the lending activities of both banks and non-bank financial institutions, the introduction of an APR cap will actually affect the activities of only the latter. This is because, in the currently prevailing equilibrium in the loan market, the APR charged by banks is lower than the level of the annual cost cap that the parliament is expected to impose. At the same time, the APR charged by non-bank financial institutions is higher compared to that of other lenders because they operate in the riskier credit segment (the so-called fast loans) and therefore the default risk premium they charge to the interest rate is relatively higher.

There is economic logic for the interest rates on payday loans to be much higher than the interest rates on loans granted by banks. The risk of the loan not being repaid is much greater due to the financial profile of the clients using these services, the term of the contract is usually short, and the loans are granted without guarantees, sureties or collateral.

Putting an interest rate cap is no different (from an economic perspective) than putting a cap on the price of tomatoes, for example, and putting a cap on the prices of goods leads to deficits. While on the one hand the APR cap will reduce the price of quick loans, the supply of loanable funds in the riskier credit segment will shrink due to the reduced profit margin. As a result, some of the demand for quick loans will be redirected from licensed non-bank institutions to pawnshops and neighborhood moneylenders, where the conditions are much worse and legal protection for the consumer is in many cases virtually absent.

It can be expected that the introduction of an APR cap will shrink the market for quick loans from licensed non-bank institutions, which will lead to job losses and have a negative effect on the state budget (although the latter can also be considered a positive effect if the net result of the reduction in tax revenues and the increase in spending on the unemployed leads to less income seizure from the population by the state).

Ultimately, the introduction of an APR ceiling on lending will deprive the poorest part of the population of access to this service or will force these people to satisfy this need in another, in most cases less favorable, way.

If lawmakers really want to help this part of society, they should (if we assume that their intervention in market processes can have a positive effect) work towards increasing competition in the sector, which will automatically lower interest rates and improve the quality of the payday loan service. An even more effective solution to the problem would be to eliminate or at least reduce poverty through economic growth and higher employment. Then the payday loan service will no longer be used by so many people and the deputies will sleep peacefully. But for this purpose, the latter must withdraw from the business life of the private sector and from people's personal lives.

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