[Song Seungseop's Financial Light] Is It Always Better to Keep Lowering the Legal Maximum Interest Rate?

Lowering the Maximum Interest Rate Reduces Borrowers' Interest Burden
Side Effects Include Low-Credit Borrowers Being Pushed Out of Formal Finance
Lee Jae-myung: "Appropriate Maximum Interest Rate Is 11.3?15%"
Criticism of "Increasing Vulnerable Groups Driven to Illegal Loans"

Finance is difficult. It is entangled with confusing terms and complex backstories. Sometimes, you need to learn dozens of concepts just to understand a single word. Yet, finance is important. To understand the philosophy of fund management and consistently follow the flow of money, basic financial knowledge must be the foundation. Accordingly, Asia Economy selects one financial issue each week and explains it in very simple terms. Even those who know nothing about finance can immediately understand these ‘light’ stories that turn on the bright ‘light’ of finance.

[Asia Economy Reporter Song Seung-seop] Everyone wants to use finance at a favorable interest rate. If borrowing the same amount of money, people want to get even a slightly lower interest rate. That way, the principal and interest payments decrease. In Korea, there is a ‘statutory maximum interest rate’ system that prevents financial companies from charging interest above a certain rate. So, is it always beneficial for consumers if the statutory maximum interest rate is lower?

The statutory maximum interest rate has been steadily lowered over time. In the early 2000s, the statutory maximum interest rate was as high as 66%. The continuously lowered maximum interest rate dropped to 39% in 2011, 34.9% in 2014, 27.9% in 2016, and 24% in 2018. Last July, it was lowered to 20% per annum. Under the Moon Jae-in administration, it decreased by about 8 percentage points in four years.

The government cites ‘reducing the interest burden on borrowers’ as the reason for lowering the maximum interest rate. They expected the principal and interest repayment amounts of citizens suffering from high interest rates to decrease. According to the Financial Services Commission, about 2.39 million borrowers were using loans exceeding 20% interest at the beginning of 2020. If the maximum interest rate is limited to 20%, it is estimated that the interest burden of 2.08 million people (87%), amounting to 14.2 trillion KRW, would decrease by 483 billion KRW annually.

The problem is that side effects also occur. The lower the maximum interest rate, the more borrowers find it difficult to borrow the desired amount of funds. Low-income and low-credit households are especially affected. The secondary financial sector or loan companies find it harder to lend money to financially vulnerable groups as the maximum interest rate decreases. Considering funding costs and default rates, they have no choice but to set high interest rates. If the maximum interest rate regulation makes it unprofitable, financial companies have no reason to lend money to vulnerable groups. Ultimately, those urgently needing funds face a greater risk of being pushed toward illegal loan companies.

The Paradox of Interest Rate Reduction... Financially Vulnerable Groups Driven to a Loan Cliff

This is confirmed by various studies and statistics. The Korea Institute of Finance analyzed the past 10 years during which interest rates dropped by 15 percentage points and found that the proportion of low-credit borrowers rated 7 or below using loan companies decreased. Meanwhile, medium-credit borrowers rated 4 to 6 increased. This indicates that low-credit borrowers found it harder to borrow from loan companies. The financial authorities also predicted that if the maximum interest rate drops to 20%, about 316,000 people might not be able to get loans from financial institutions during the 3 to 4 years when their loans mature. Among them, 39,000 are expected to be pushed toward illegal private loans.

The government and financial authorities plan to respond to side effects by expanding policy-based microfinance supply and strictly cracking down on illegal private loans. Safe Net Loan II and Saessal Loan 15, launched as follow-up measures after the maximum interest rate reduction, are representative examples. Also, policy microfinance institutions have activated counseling related to loan rejections and connections to debt adjustment.

On December 30 last year, Lee Jae-myung, the Democratic Party presidential candidate, attended a forum hosted by the Korea Newspaper and Broadcasting Editors Association held at the Press Center in Jung-gu, Seoul, delivering the keynote speech. / Photo by the National Assembly Press Photographers Group

However, the controversy over the maximum interest rate seems to be reigniting as the presidential election approaches. Lee Jae-myung, the Democratic Party presidential candidate, proposed a statutory maximum interest rate in the 10% range as a campaign pledge. Citing research from the Gyeonggi Research Institute, Lee claimed that “the appropriate level of the statutory maximum interest rate is about 11.3 to 15%.” He also pointed out, “The base interest rate is 0.5%, but forcing low-income people to pay 20% interest just because they are poor is against the spirit of the Constitution and contradicts the community principle of ‘helping the weak and restraining the strong.’”

Opposing voices also emerged. After Lee’s pledge, Yoon Chang-hyun, a member of the People Power Party, posted on his social media, “Ideally, it might be good to support those in difficulty with 0% interest loans. But finance is not charity.” He criticized, “After the maximum interest rate was lowered by 4 percentage points in 2018, the number of loan company users halved, while the number of those pushed into illegal private loans increased by 50%. Look at their tears.”