[Initial Insight] Raising the Legal Maximum Interest Rate Will Ease the Burden on Low-Credit Borrowers

They say this: although social distancing has ended, the aftermath of COVID-19 still lingers in every alley, tormenting the common people. Economic growth rates and national income growth rates are steadily declining, and in such circumstances, it is difficult for anyone to live while paying interest rates exceeding 20%. Since loan companies exploit low-credit borrowers by using the legal maximum interest rate as bait, excessively high interest rates must be curbed to protect financial consumers.

What they do not say is this: during periods of rising interest rates, the legal maximum interest rate can actually strangle low-credit borrowers. As the funding cost rate rises above the loan interest rate, loan companies face a reverse margin crisis, leading them to completely cut off credit loans to low-credit borrowers or refuse to extend maturities. With the last refuge gone, those who have nowhere else to borrow money become credit delinquents or have to turn to illegal loan sharks.

Rewinding to November 2020, the ruling party and government meeting decided to lower the legal maximum interest rate from 24% to 20%. The ruling party floor leader said, "The Bank of Korea’s base interest rate is 0.5%. In a low-interest environment, the maximum interest rate of 24% is anachronistic." At that time, this statement was persuasive, and the Financial Services Commission swiftly took measures to reduce the rate. No one present then could have guessed that two years later, the base interest rate would reach 3%.

The decision back then is not wrong. What is wrong is the current ruling party and government who say nothing even though the situation has changed 180 degrees. When the base interest rate rises → the funding rates in the secondary financial sector, that is, the rates on credit card bonds and deposit rates, also rise → loan interest rates should rise accordingly. Nevertheless, the political sphere, conscious of votes, has no intention of raising the maximum interest rate once lowered.

The Korea Development Institute (KDI) stated that if the current legal maximum interest rate of 20% is not raised, about one million low-credit borrowers will be unable to borrow money even from the secondary financial sector. The political sphere’s true intention is that they cannot afford to be criticized by 43 million people just to save one million people on the brink of a cliff. Although some argue that policy financing can provide support, how many citizens would blindly agree to spend taxes on low-credit borrowers who don’t even know what they borrowed for?

Banks are also anxious. This is because the "grammar of lending" is about to be broken. An executive in charge of risk at an internet bank said the situation is extremely urgent. "Because the secondary financial sector cannot lend to low-credit borrowers due to the legal maximum interest rate and concentrates loans on high-credit borrowers, the sequence from commercial banks → savings banks → loan companies collapses. If the delinquency rate of low-credit borrowers who cannot borrow money surges, the entire financial sector will be caught in a whirlpool."

If the legal maximum interest rate is a political issue, it must ultimately be resolved politically. A solution that can persuade public opinion by choosing different words has also been proposed. "There is a need to introduce a 'linked legal maximum interest rate system' where the legal maximum interest rate fluctuates according to the market average interest rate" (Kim Miru, KDI Research Fellow). Rational interest rate adjustments are possible without using the term 'increase.' It is also a method for the secondary financial sector to raise their voices first and for financial authorities to propose it to the political sphere. To avoid becoming an unwitting bad Samaritan, we must first abandon the stubborn belief that lowering interest rates is always good.