End 2014, the World Bank produced a report that presents the findings of its stock-taking exercise to determine the number of countries currently capping interest rates on loans. The last financial crisis has reopened the debate on interest rate controls as a tool for consumer protection and more and more authorities have decided it is a useful tool to add to their portfolio of regulatory measures to promote sustainable credit markets (e.g. new caps in El Salvador (2012), the Kyrgyz Republic (2013), and Zambia (2013) and more restrictive caps in Japan). The report looks at the main characteristics of the regimes countries used, including the source of rate-setting authority and the methodology and criteria for establishing the cap. It also provides some details of the effects of these regimes and they make a number of policy recommendations. The findings confirm the pertinence of interest rate restrictions with 76 countries with caps in credit market prices (37% of these (28 countries) have these caps encoded in usury laws, 32% (N=24) in interest rate laws and 11% (N=9) relying on de facto ceilings as the source of authority. The entity responsible for setting the cap is usually the central bank, but also can be the court, the legislature, the parliament, or the minister of finance). Unfortunately, some countries impose the cap on the nominal interest rate only whereas the majority base it on the effective interest rate or on the annual percentage rate (which incorporate commissions and fees). Only Poland was found to have separate regulations to control fees and commissions. In terms of application of the cap, the evidence shows a mixed preference for using absolute interest rate caps (24 countries) and relative ceilings (32 countries - almost all of which use an endogenous benchmark rate (N=26). Many countries apply a multiplication coefficient over the benchmark rate to determine the final level of the cap. In addition, few countries have one unique interest rate cap, and most have opted for setting different ceilings for different types of credit, amounts borrowed, or maturities.
Regarding the effects of these caps, the Report points to negative effects found in isolated countries. These include: a withdrawal of financial institutions from the poor market segments (e.g. WAEMU countries, Nicaragua), an increase in illegal lending (e.g. Japan and USA), a decrease in the licensing of new lending institutions (e.g. Bolivia), an increase in the total cost of the loan through additional fees and commissions (e.g. Armenia, Nicaragua, and South Africa), and a decrease in product diversity (as in France and Germany). Interest rate caps, however, have partially worked to lower interest rates in the credit union sector of the United States.
While the paper does conclude that there are more effective ways of reducing interest rates on loans over the long run and of improving access to finance, interest rate caps are seen as an effective way to control for extortionate irresponsible lending and as a useful policy tool for reducing interest rates on loans and increasing access to finance. The other measures mentioned as a complementary to an interest rate restriction regime are those: that enhance competition and product innovation, improve financial consumer protection frameworks, increase financial literacy, promote credit bureaus, enforce disclosure of interest rates, and promote microcredit products.
Interest Rate Caps Around the World: Still Popular, But a Blunt Instrument (World Bank, 2014)
Among other common forms of government financial control, caps on interest rates have been declining over the past several decades as most industrialized countries and a rising number of developing countries continue liberalizing their financial policies. However, in several countries the last financial crisis reopened the debate on interest rate controls as a tool for consumer protection. This paper undertakes a stock-taking exercise to determine the number of countries currently capping interest rates on loans. The paper looks at the main characteristics of the regimes countries have used, including the source of rate-setting authority, the methodology, and the criteria for establishing the cap. The paper finds at least 76 countries around the world currently use some form of interest rate caps on loans -- all with varying degrees of effects, including the withdrawal of financial institutions from the poor or from specific segments of the market, an increase in the total cost of the loan through additional fees and commissions, among others. The paper concludes that there are more effective ways of reducing interest rates on loans over the long run and of improving access to finance: measures that enhance competition and product innovation, improve financial consumer protection frameworks, increase financial literacy, promote credit bureaus, enforce disclosure of interest rates, and promote microcredit products. Such measures should be implemented in an integrated manner. However, if caps are still considered a useful policy tool for reducing interest rates on loans and increasing access to finance, they should be implemented in accord with the caveats described in the paper.
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Maimbo, Samuel Munzele and Henriquez Gallegos, Claudia Alejandra, Interest Rate Caps Around the World: Still Popular, But a Blunt Instrument (October 1, 2014). World Bank Policy Research Working Paper No. 7070. Available at SSRN: http://ssrn.com/abstract=2513126