NCPA - National Center for Policy Analysis


November 2, 2007

Charge 80 percent per year on a loan in the United States and you're called a usurer.  Charge 80 percent per year on a loan in Latin America or Africa and you can be a poverty-alleviation charity.  Outrage over usury is based on a fundamental belief that credit at high rates does borrowers more harm than good.  But even consumers making flawed decisions may be better off when they can borrow from regulated financial institutions at "excessive" rates, say Dean Karlan, assistant professor of economics at Yale University and president of Innovations for Poverty Action and Jonathan Zinman, assistant professor of economics at Dartmouth College.

To prove this, Innovations for Poverty Action, a non-profit, worked with a South African finance company to randomly choose some just-below-the-normal-approval-bar applicants to receive a four-month installment loan.  The lender charged its normal rate: a 200 percent annual percentage rate (APR). The remaining, just-below-the-normal-approval-bar applicants (the "control group") were rejected in line with the lender's normal credit policy. The results:

  • The new borrowers did report higher stress and depression levels than the control group.
  • But overall, the borderline loans objectively did more good than harm.
  • The findings are striking because governments that restrict credit access do so on the premise that consumers make themselves worse off by borrowing at high rates.

To make the system better, regulators products and their presentations should be designed to guide folks to the choices that suit them best, say Karlan and Zinman:

  • Better loan-disclosure laws, for example, might help make sure borrowers are fully aware of the terms of their commitments.
  • Opt-out (instead of opt-in) payroll savings plans could help employees accumulate savings.

Further, we owe it to consumers to consider the evidence, and demand more of it, before swinging the pendulum away from access to credit, say Karlan and Zinman. This means more scientific evaluations, using gold-standard randomized methodologies such as the one described above.

Source: Dean Karlan and Jonathan Zinman "In Defense of Usury," Wall Street Journal, November 1, 2007.

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