Don’t criminalise usury

There is a difference between ordinary lenders and thugs

November 27, 2017 12:15 am | Updated 12:15 am IST

New Indian Currency with House Model - 3D Rendered Image

New Indian Currency with House Model - 3D Rendered Image

The recent suicides of a Tamil movie producer in Chennai and a family of daily wage earners in Tirunelveli have led to strong demands for punitive action against moneylenders. Both cases have been linked to harassment by financiers accused of demanding high interest on loans given to the victims.

The campaign against high-interest lending, while well-intended, fails to differentiate between ordinary lenders who charge high interest on loans and thugs who are ready to launch physical attacks against borrowers and mentally abuse those who fail to pay up. Even in the formal financial system, lenders can offer loans at relatively higher interest rates usually by assuming greater risk. In the case of default, however, the lenders know that they cannot torture borrowers to get back their money. So, they are generally wary of making high-risk loans unless they have access to collateral or are ready to negotiate a proper settlement in the case of default. This holds true largely even in the case of financial transactions within the shadow banking system. So, it is not high-interest lending per se that leads to the abuse of borrowers by lenders. Instead, when aggressive and politically powerful lenders deal with weak borrowers, the inability to repay leads to violence. In such cases, the lending standards are generally looser as the lender, who can easily resort to violence to extort money, has little reason to worry about the creditworthiness of the borrower or other matters of due diligence. Usually, the local law enforcement authorities also function hand in glove with these lenders, leaving borrowers in extreme distress with no legal recourse. This, in turn, leads to many unfortunate cases of borrowers taking their lives. The blame for deaths caused due to such harassment should lie squarely on the government’s inability to uphold the law and protect borrowers.

Any attempt to outlaw all high-interest, or usurious, lending, meanwhile, would be to throw the baby out with the bathwater. It will make life worse for borrowers who genuinely benefit from informal lending, while doing nothing to address the menace of violent moneylenders. A better way to lower lending rates, particularly in rural India, would be to allow the free flow of capital in search of investment opportunities that offer abnormal returns. After the Reserve Bank of India’s decision to deregulate microfinance, for instance, several microfinance institutions entered the rural market attracted by the high return on capital offered by the sector. This inflow of capital eventually helped lower borrowing rates by bidding up the price of investment opportunities. Any law to cap lending rates, on the other hand, will only destroy the incentive to invest in untapped markets and increase the borrower’s cost of capital. That said, it would be foolish to think that microfinance and other financial innovations can prevent deaths caused by what is a law and order problem.

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