firmly in place has been confirmed through an abundance of historical evidence.
Do Not Interfere With Interest Rates
The government might want to interfere with interest rates in the private (or consumer) loan market, where it feels obliged to protect the low-income populace. The "Interest Control Act", which had been in effect until the IMF foreign exchange crisis, and the "Act on Usurer Registration and Borrower Protection" superseding it after the IMF crisis, are the laws intended to do such a job.
Yet, it is unclear if the low-income populace can really benefit from the government's such interference with interest rates in the private/consumer market. One historical example related with the city of Texarkana in the U. S. may provide a clue to this question.
Interestingly, the borderline of Arkansas and Texas passes through in the middle of the city of Texarkana. Thus, the city is divided into two parts: one where the usury law of Arkansas is applied and the other where the Texas' law freeing interest rates is applied. In the area where the usury law is applied, moneylending businesses such as pawn shops are prospering, while modern financial institutions such as banks are flourishing in the other area where interest rates are not controlled.
As a result, when borrowing money to buy a car, people in the Arkansas area should pay higher interests than those in the Texas area(except for those who could go over and borrow from banks in the Texas area), because the interest rates in the Arkansas area are higher, where pawn shops charging higher interest rates prevail, while the rates in Texas are much lower, because they could borrow from banks. Another noteworthy fact is that lots of poor people who have to borrow from pawn shops live in the Arkansas area and the living conditions there are very low. On the other hand, more modern restaurants, cultural facilities, and residental buildings are abundant in the Texas area.
The first lesson from this example is that sometimes the government's efforts aimed at protecting the low-income populace can have an adverse effect on them. Second, even if such interfering system could provide lower interest rates to them, the net effect would be rather harmful to the low-income populace. For the deterioration of business conditions due to the lack of efficient financial markets and the resultant shrink of job market will decrease their income.
To the low-income people it would be more beneficial if they are hired, and pay back for the loans they owe with their income, even though the interest rates are slightly higher, rather than trying to pay back the lower interest rate loans without jobs and incomes. Let's suppose a man goes bankrupt due to the failure of his business. He would face two possible situations. One is: From the failed state, he loses his creditworthiness, and thus may not be able to recover from the bankruptcy. The other is: He might manage to borrow money even from the money-lending institutions and take the courage to start a business anew. Which situation would make him happier, and more conducive to the national economy?
In order for a society to grow harmoniously and dynamically, all members should have the belief that they could raise their social/economic status if they try hard enough. To heighten such social mobility, many factors may be required. But the most critical factor among them is to create an atmosphere in which any individual is able to secure money as easily as possible to start a business.
To develop such financial institutions (or individual money-lenders) that can lend money to the low-income people who have lost their creditworthiness (or who have yet to develop their creditworthiness), there must be an atmosphere which gives such institutions or lenders the confidence that they would not go broke even though lending money to such risky customers. Let's suppose a financial institution (or an individual lender) lending money to street venders in the Namdaemoon market. To this institution or lender, two problems emerge. Firstly, they have to analyze the creditworthiness of individual venders which varies drastically day by day. Secondly, they have to put in lots of efforts to contact them on a constant basis for collecting interests on the loans to them. Although the efforts put in to collect daily interest could be used also to check out each individual's creditworthiness, such financial institutions will be likely to incur higher costs in both evaluating individual venders' creditworthiness and managing money lent to them. The cost of the small lending business would look especially higher when compared to those of the lending business to medium- to large-sized companies.
The cost of raising funds solely for the small lending is also likely to be higher than those of traditional banks. Considering the higher cost of raising funds, the lower creditworthiness of the lower-income people, and the labor-intensiveness of conducting such businesses, Setting a ceiling on interest rates of this market in order to protect the low-income people is very likely to make such institutions to be hesitant to lend money to the people whose creditworthiness is lower than a certain level. This is why limitations on interest rates in the credit card loan markets, which are supposed to help the low-income people, have been lifted both in the US (except for a few individual states) and Britain.
More recently, there was a heated debate in Japan over the level of interest rates on the loans for the low-income people, which was sparked by the supreme court's decision on Jan. 1, 2006 that the interest rates of 15~20% on the loan to the lower-income people were unlawfully high. Thus, a movement was brought into being to lower the ceiling of interest rates for the low-income people (now 29.2%). But the small lending institutions raised strong objections, especially foreign ones. They argued that the ceiling on interest rates would force them to lend money only to those people commanding relatively high credit ratings and that this would push the poor credit people to the world of loan sharks, who had been known to act beyond the reach of the law, such as threatening the borrowers' lives.
Proponents of limiting the interest rates tend to insist that lifting the limitations would allow the interest rates to rise without limits. However, this problem could be easily and completely solved if the government introduces a system of competition among the lending institutions.
Another benefit of liberalizing the financial system is, as we saw in the Texarkana example, that it enables the more competitive financial institutions to lead the market, and thus allows the low-income people, who used to have no choice but to go to the high charging institutions, to have an increased probability of borrowing cheaper money from efficient banks.
Even right after liberalization of the financial system, banks might not be able to lend money directly to the low-income people. Yet, they surely will try very hard to establish affiliated loan companies which would specialize in lending to them, because this is an efficient way to expand their business bases to the low-income customers. That is to say, the banks can accumulate the credit transactions records with such people by having their affiliated loan companies to lend to them and then, after their credit levels rise above a certain level, the banks themselves may come forward to lend money directly to them. This way of doing business with the poor people will enable banks to enlarge their customer bases cheaply and efficiently, thus benefiting the banks with increased profits and the low-income people with cheap loans.
This is the best possible win-win strategy both to the financial institutions and lower-income people. There are even more benefits resulting from liberalization of the financial system. As everybody knows, our economy is losing vitality. If we fail to overcome this difficult situation, our economy might be swamped by China, on the one hand, but unable to catch up with Japan on the other. Therefore, we must modernize our financial system as quickly as possible to escape such a dilemma, which is impossible without liberalizing interest rates.
There is an example where liberalization of the financial systems leads to the spectacular development of a financial industry, which in turn maximizes economic development. In 1965, when Singapore was just liberated from the colonial rule, only a few British local banks were operating in the underdeveloped financial system and its economy was suffering from stagnation. Under such difficult conditions and despite the constraints of the Cold War, Singapore liberalized the financial system completely, allowing even the banks from the Communist bloc to operate in the country, and permitting offshore financing without limits. As a result, Singapore has become the financial center in Southeast Asia and, moreover, its economy has developed to the level of an advanced economy.
I want to emphasize again. In order to revive Korea's economy from sluggishness, there's no better solution than liberalization of the financial system, which will be impossible without liberalization of interest rates. If this strategy is put into practice, the life of the low-income families will be improved automatically. From what we have seen so far, it is now very evident which path, either restriction of interest rates or their liberalization, should be taken.
Kim, Haneung (a rep. of Free Citizen's Alliance Korea)
