Three Cheers for Usury

Charge 80% per year on a loan in the U.S. and you're called a usurer. Charge 80% on a loan in Latin America or Africa and you can be a poverty-alleviation charity.

Via Tyler Cowen, from today's Wall Street Journal. The quote is from the authors of a new paper with the slightly less than punchy name "Expanding Credit Access: Using Randomized Supply Decisions to Estimate the Impacts."[PDF] In the paper, they examine the results after a South African lender encourages its loan officers to approve a random selection of their near-miss loan applicants. Looking at loan repayment and credit two years later they find:

…the marginal loans produced significant benefits for borrowers across a wide range economic and well-being outcomes. We also find some evidence that the marginal loans were profitable for the Lender. The results suggest that consumer credit expansions can be welfare-improving.

In other words, everybody wins. Sweet.

Comments

[tarran]

No, it means that the banks are making inaccurate predictions as to which loans will be profitable and which will be losses.

After all, if they were accurately predicting the risk, the people they wanted to decline loans to would default more often than the people they decided to make the loans to, and the test program would have hurt the bank's bottom line, not improved it.

[NotThatDavid]

It means both. That's the problem, and expanding eligibility is a viable solution.

[Kwix]

In other words, everybody wins. Sweet.

Unless you are following Sharia.

[nate]

Charge 80% per year on a loan in the U.S. and you're called a usurer. Charge 80% on a loan in Latin America or Africa and you can be a poverty-alleviation charity.

You neglect to mention that inflation is probably much higher in these Latin American and African countries than here in the U.S. You should compare real interest rates before making sweeping generalizations.

[madpad]

As important as interest rates is the default rate.

It's not usery to charge 80% interest when the default rate is 20% (as reported in the very piece Ward extols).

Here in the states, the default rate is much lower - hovering 'round 1-3% overall depending on the industry.

What makes lending at 80% apr usury in the U.S. is that the folks typically being charged 80% are often (though no always) low income, poorly educated folk ignorant of many basics of personal finance and credit.

[David]

tarran is right. This shows that the bank's methods for calculating risk were overly conservative.

[Russ R]

madpad:

"What makes lending at 80% apr usury in the U.S. is that the folks typically being charged 80% are often (though no always) low income, poorly educated folk ignorant of many basics of personal finance and credit."

And what makes lending at 80% apr a poverty-alleviation charity in Latin America or Africa is...

"that the folks typically being charged 80% are often (though no always) low income, poorly educated folk ignorant of many basics of personal finance and credit."

[Buffy]

Here's what folks don't get:

If a bank issues a loan (via, say, a credit card) to me at 29.9%, what the bank is saying in effect, is that every dollar they invest in me, will return 29% per year pretty much forever. How stupid is that!?

[Russ R]

No Buffy,

what the bank is saying is that for all the loans it makes on credit cards to people like you, after a certain percentage of people default on the loans, and it sells the loans to collection agencies at a loss, in order to cover its administration costs associated with paying its employees, marketing, processing applications, verifying applicant suitability, mailing cards, processing transactions, making payments to merchants, floating payments during the interest-free grace period, managing security, mailing monthly statements, collecting and processing payments, and reporting delinquent accounts to agencies, and to still make an after-tax return above the bank's cost of capital it needs to charge borrowers a 29.9% APR.

Hope that helped.

[R C Dean]

If a bank issues a loan (via, say, a credit card) to me at 29.9%, what the bank is saying in effect, is that every dollar they invest in me, will return 29% per year pretty much forever. How stupid is that!?

Yeah, banks are known for being stupid about money.

Buffy, what the banks is sayin is every dollar they loan to you will return 29% per year until you pay it back. The bank actually has a pretty good idea, actuarially speaking, when (and/or if)that will occur.

[madpad]

"that the folks typically being charged 80% are often (though no always) low income, poorly educated folk ignorant of many basics of personal finance and credit."

Wrong, Russ...read the paper.

[karlan]

Nate said: "You neglect to mention that inflation is probably much higher in these Latin American and African countries than here in the U.S. You should compare real interest rates before making sweeping generalizations."

No, those are common, and they are real rates, not nominal. 80% real is actually lower than some NGO's charge. And higher than others. South Asia is an exception, microcredit there charges considerably lower than other parts of the world (10%-25% apr is common). If you want to see data on this, check out http://www.themix.org.