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On December 14, 2023, Sen. Jack Reed (D-R.I.), along with seventeen other Democrats, introduced the deceptively named Predatory Lending Elimination Act (S. 3549). The bill wrongly expands the 36 percent annual percentage rate (APR) cap that currently applies to active-duty members of the armed forces and their dependents. Under the bill, the rate cap would apply to all consumer lending offered by banks, credit unions, and nonbank financial companies. Products that are not subjected to the bill’s APR cap include residential mortgages, certain auto loans, and loans made by federal credit unions that are already subject to an 18 percent cap and a 28 percent cap for payday loan alternatives. The bill also empowers the Consumer Financial Protection Bureau (CFPB) by giving the agency essentially unlimited authority to draft rules—in consultation with the Department of Defense—to implement the provisions in the bill.
This legislation is significantly flawed because rate caps limit the availability of credit. According to one paper studying Illinois’s 36 percent APR cap, the rate restriction “decreased the number of loans to subprime borrowers by 38 percent and increased the average loan size to subprime borrowers by 35 percent.” A survey discussed in the paper found that the “interest-rate cap worsened the financial well-being of many of [the small-dollar-credit] borrowers.”
Congress already recognized that rate caps are distortive. Prior to 1980, the Federal Reserve’s Regulation Q imposed interest rate caps on bank deposit accounts. Regulation Q was gradually phased out between 1980 and 1986. According to a document published by the Federal Reserve Bank of St. Louis, “Congress concluded that interest rate ceilings created problems for depository institutions, discriminated against small savers, and did not increase the supply of residential mortgage credit.” Similarly, the rate cap in Sen. Reed’s bill would distort credit allocation and reduce the availability of credit to consumers.
Some Republicans have not heeded the warnings of imposing government-mandated price controls. Sen. Josh Hawley (R-Mo.) introduced legislation that utilizes the same tactics as Sen. Reed’s bill. The bill applies an APR cap of 18 percent to credit cards issued in the U.S.
Introducing a price control on interest rates will produce unintended consequences and ultimately backfire. The misguided notion of imposing government-mandated rate caps rests on erroneous reasoning. In practice, price controls are infeasible, contravene free market principles, and harm consumers’ access to credit.
According to one Forbes article, 22% of Americans are unbanked or underbanked. Unbanked Americans have no bank account, and the other 16% of Americans who are underbanked have bank accounts but rely on payday loans and other short-term financing. Payday lenders offer access to short-term credit for those who are otherwise shut out of obtaining that credit from conventional sources.
Higher interest rates are charged to account for greater risk and expenses. One article in the Fordham Journal of Corporate & Financial Law from 2007 describes how payday lender profit margins are 7.6% compared to 13% for commercial lending institutions. The article also points out that loan losses as a percentage of outstanding loans stand at about 17-25% for payday lenders depending on the specific business model, while well-known commercial lenders experience loan losses of roughly 5%. This highlights the significant differences in how these businesses function.
A cap on rates would further reduce margins for lenders and limit access to credit for consumers. This market distortion would ultimately reduce the availability of lending services, which would hurt lower-income borrowers who need immediate access to credit to pay for rent, groceries, or utilities.
By limiting the availability of short-term credit options, government regulations could force borrowers into more precarious financial situations. It is vital that Congress avoids distorting a market that provides services to consumers in need of short-term credit.
Members of Congress should oppose S. 3549 and any legislation that imposes distortive price controls on consumer credit.