April 7, 2008

How High is Too High?

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Microfinance has been praised for its tangible contributions to poverty alleviation, but the media tends to sidestep a certain detail: what do these MFIs actually charge as interest?
It’s a basic question, but the answer would likely baffle the uninformed public. Whereas credit card rates in the US typically linger below 30 percent, interest rates among MFIs can range from around 20 to 100 percent. What then, can be defined as usury?
Historically, “usury” was first used to describe any attachment of interest to a loan whatsoever. Moral codes questioned this charge, and so the stigma was born. The Vedic texts of India, the Buddhist Jataka, Islam’s Quran, the Old and New Testaments, and the Talmud all contain criticism of interest. Western philosophers like Plato, Aristotle, the two Catos, Cicero, Seneca, and Plutarch also condemned interest to some extent. However, as time trotted along, interest became increasingly pervasive. Today our financial markets are actually interest-based and the definition of usury has shifted accordingly – it now only marks “exorbitant” levels of interest.
Debate then stands regarding the definition of “exorbitant.” In the US, the limits of the adjective haven’t been clearly identified. Fewer than half of US states put a limit on credit card interest rates, and the major credit card issuers have based themselves in those states that don’t. Citibank, for instance, moved its credit card business in 1981 to South Dakota, where regulations were more favorable. Other forces are then left to define and eliminate “exorbitant” rates. Actually, a 1978 Supreme Court decision allows national banks to overrule state usury laws with the standards set in place by only one. That is to say, companies can select a state with preferable laws and export those rates around the country to all of their corporate branches.
Opinions on these usury laws vary. Some argue that usury restrictions are needed to protect low-income borrowers from exploitation. Even Adam Smith, champion of the invisible hand, recommended interest rate limits in his Wealth of Nations. Others though, point to the benefits of credit opportunities, and call instead for structural changes like consumer-driven credit limits. Enough competition, they argue, will drive the costs down.
Is this why the US media avoids the discussion? Usury hasn’t been plainly defined here, and the mess only multiplies as you zoom out beyond the domestic scene. MFIs exist globally, in a broad range of cultural, regulatory, and financial environments. They have been set apart from big financial players with their “micro” designation, and are generally confronted with higher operation costs. With miniscule default rates, there is also less threat of their setting debt traps. Finally, MFIs themselves are a grab bag. They can include commercial banks, cooperatives, credit unions, post offices, retail chains, and NGOs. It doesn’t seem appropriate or feasible then, to compare their rates to those in the US.
The question of usury in microfinance needs to be broached, but there’s really no neat answer. Maybe it’s best then that the mainstream media, with their dangerous addiction to oversimplification, continue avoiding the subject.