Why are there so many countries that apply interest rate caps/ceilings?

Question

Interest Rate Ceiling is "the maximum interest rate that a financial institution can charge a borrower for an adjustable rate mortgage or loan according to the contractual terms of the mortgage or loan."

According to this research paper interest rate cap seems to generate more negative effects that positive ones:

Regarding the effects of these caps, the evidence points to more negative effects, such as a withdrawal of financial institutions from the poor or from specific segments of the market (as in WAEMU countries and Nicaragua), an increase in illegal lending (for example, in Japan and the United States), a decrease in the licensing of new lending institutions (as in Bolivia), an increase in the total cost of the loan through additional fees and commissions (as in Armenia, Nicaragua, and South Africa), and a decrease in product diversity (as in France and Germany).

Out of curiosity, I have checked the APR for loans provided by a company that also operates in my country and it is about 300% for a maximum amount over the maximum time span (maximum amount should minimize fixed commissions influence, the currency is a stable one).

APR computed by some site for a personal loan with the worst credit score is about 30%.

So, the difference is very large and it would make sense to have interest rates caps, to avoid such discrepancies.

However, the aforementioned paper concludes that these caps have more negative effects that positive ones:

Question: Why are there so many (at least 76 countries) countries that apply interest rate caps/ceilings?

Answer 1

There is a lot to speculate about Interest Rates Cap. The biggest issue with the concept is not that if it should exist or not but how often should be reformed, and how localized.

The historical argument supporting Interest Rates Cap (IRC) is usury. It's a very real problem even today. Notice that the paper you quote is not fully dismissing IRC but prompts governments to adresse its caveats.

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 our caveats.

It also seems to mention some informations that are not cited and some others that I would argue are not up to date. You see just a bit after this paper was released the UK has added new rules for the cap system.

“We created a powerful new consumer regulator to regulate the payday lending industry and legislated to require the FCA to introduce a cap on the cost of payday loans. This is all part of our long-term economic plan to have a banking system that works for hard-working people and make sure some of the absolutely outrageous fees and unacceptable practices are dealt with.” by George Osborne

Previous studies had already shown the IRC is particularly nocive to MFIs (Monetary Financial Institutions) (as opposed to smaller and larger banks, Figure 2):

That basic interest rate caps are most likely to bite at the lower end of the market is intuitive; interest rates charged by microfinance institutions are generally higher than those charged by banks6 and this is driven by a higher cost of funds and higher relative overheads. Transaction costs make larger loans relatively more cost effective for the financial institution.

These are institutions that usually make smaller loans with bigger rates (securities, credit cards, etc.). By adding new regulation rules the UK expected to control some of its bad household debt. As of today its a bit unclear if it worked or not (there are outstanding circumstances to UK, Brexit included).

Conclusion: In any case IRC is not a notion that will likely disappear. It tends to be reformed or implemented whenever a new crisis appears. And it tends to be further deregulated when things are going well. Currently many countries apply IRC because there is a real urgency in controlling debt. This includes household debt. Each small debt loan that needs to go to court has a cost for the state. And even more relevant, if left unchecked, it can lead to serious societal problems (too many indebted people will decrease purchase power).

Answer 2

Normally, interest rate ceilings are part of the more general laws against usury. It's just the USA has had problems in implementing them.

Usury has been considered a crime, and even a sin in all the main religions of the world (hinduism, buddhism, judaism, christianism and islam), which is the reason there is still considered something to ban or avoid even in our neo-liberal capitalistic world of today.

Answer 3

There are several reasons for that:

1. The general concept of "concentrated benefits and dispersed costs".

   The costs of lack of caps are very diffuse (many of the downsides of the caps as listed in your question apply to a large amount of people in small ways). The benefits of caps are rather concentrated - namely, to politicians (see #2 below) that get electoral support by "standing up for poor people"; and large lenders that eliminate niche competition from loan sharks.

   Additionally, the costs aren't just dispersed, they are rather invisible and intangible for most people. It's not like someone will Germany will go "Oh, I really want that weird loan. Oh, can't get it - let me blame politicians who voted for caps". Most people don't read specialized finance research which explains the downsides and costs of caps.

   And the benefits of not having the caps are also hidden among the poor population - someone poor who couldn't afford a shark loan at 300% before, now can't get a 20% loan either due to lacking good credit. No loan either way. So they don't really see much difference, despite being the primary theoretical beneficiary of eliminating caps according to your research. And someone who was going to get a legal 300% shark loan before, now will get an illegal one, without realizing that they will be paying even worse interest due to the loan being illegal.

2. There's a strong bias in modern social democratic politics to "protect people from themselves".

   Thus, instead of "well, people know what they are doing, if 300% APR is not worth it for you, you won't borrow at 300% APR" attitude, it becomes "you don't know that 300% APR is bad for you, so we need to protect you from inadvertently making a mistake of borrowing at that APR".

   Whether such attitude is correct or not largely depends on one's ideology; one can make cogent arguments both ways (on one hand, we know that people are not as smart as they think they are - see all the behavioral economics research. Nobody is Homo Economicus. On the other hand, we know that wisdom of the crowds does work; and central planning nearly always sucks compared to just letting people do their thing, as evidenced by economic results of socialist vs. capitalist economies).

   Additinally, we know from past examples that most political leaders mostly vote for whatever benefits their elections or their ideological views, without regard to larger-picture economic consequences of the laws they pass. Oh, and being people too, they also share that same "aren't as smart as they think they are" issue.