An article released last Wednesday (August 12, 2020) by the Federal Reserve Board of Governors, provides strong support for NILA’s position that consumers suffer when small dollar loan availability is limited by caps on Annual Percentage Rates (APR).
The article, The Cost Structure of Consumer Finance Companies and Its Implications for Interest Rates: Evidence from the Federal Reserve Board’s 2015 Survey of Finance Companies, reviews and discusses a number of studies, including a 1972 report by the National Commission on Consumer Finance (NCCF). It reviews the NCCF report’s analysis of the costs involved in extending credit and their implications for setting interest rates, noting that these costs amounted to:
“…a lengthy list of activities that a lender must undertake to grant credit, process payments, and collect delinquent payments or incur bad debt expenses. To originate loans, lenders must solicit customers, take applications, evaluate loan requests, and disperse funds. After origination, operating expenses are incurred to process a series of payments over the term of the loan and to maintain records of payments received…. Lenders must monitor loans for delinquent payments and contact delinquent borrowers…. Processing such accounts can be quite costly. Other accounts are written off, resulting in loan losses”
The NCCF report found that break-even interest rates for loans made by consumer finance companies were higher at small loan amounts because of the impact of fixed operating costs and concluded that that “[when] rate ceilings are below the levels indicated [by the estimated break-even rates], staff studies show that finance companies can stay in business only by greater loan sizes, limiting their risk acceptance to more affluent consumers, and maintaining large volume offices.” The article notes that “the NCCF’s conclusions are still valid today.”
NILA welcomes the fact that the Fed’s analysis supports our contention that the APR rate caps amount to an outright ban on small dollar loans for non-bank borrowers. As the article points out, If small loan revenue is constrained by rate ceilings, only large loans will be provided. Consumers who need a small loan or only qualify for a small loan would not be get one. This has an effect on the financial capability of entire sections of society, who no longer have the tools they need to manage their finances effectively and are cheated out of a chance for financial mobility through safe, affordable, credit-building loans.
SOURCE: Federal Reserve