[1mmGeumyungTalk] "We Must Stop Small Loan Businesses"... Good Intentions but Parliament Fails to See Reality

"Bill Proposed to Strengthen Private Lending Capital Requirement to 30 Million Won"
Good Intentions but Concerns Over Proliferation of Illegal Lenders

Same with Legal Maximum Interest Rate Reduction
Good Intentions but Low-Credit Borrowers Pushed Outside the System

A bill has been proposed to completely prevent small-scale lenders from entering the market. On the 15th, the National Assembly introduced an amendment to the Loan Business Act (led by Kim Young-sun, a member of the People Power Party) containing such provisions. The intention is good. Currently, anyone with at least 10 million KRW in capital can register with the city or provincial governor to operate a loan business. The amendment pointed out that this 10 million KRW requirement is too low. It criticized that this leads to a proliferation of small-scale lenders and causes harm to financial consumers. Therefore, it proposed strengthening the capital requirement for loan businesses to at least 30 million KRW to prevent such damage.

Although the intention to protect financial consumers is commendable, the financial industry and government view this bill with concern. There is worry that illegal lenders will increase instead. Loan businesses operate under a registration system, not a licensing system. Large companies, such as those with two or more branches or assets exceeding 10 billion KRW, register with the Financial Services Commission, while smaller companies register with local governments. After the Asian financial crisis, as illegal private loan damage increased, the government enacted the Loan Business Act in 2002 to bring private lending from the shadows into the light.

Initially, incentives were needed to attract registered companies. Therefore, loan businesses were allowed to charge interest rates above the legal maximum (up to 49% annually). This was to maximize the number of companies under government supervision. However, this incentive disappeared in 2018 when the legal maximum interest rate was lowered to 24%. The legal maximum interest rate was further reduced in 2021 and is now around 20%.

A financial industry insider said, "Most loan businesses are small-scale, and now they can only charge interest up to the legal maximum of 20%. If the capital requirement is raised, they will withdraw their registration and operate illegally. At least now, since they are registered, the government can conduct inspections, but unless police forces monitoring illegal private loans are increased severalfold to catch them all, the side effects will only worsen."

[Image source=Yonhap News]

The government also takes a cautious stance. The goal of the Loan Business Act is to increase the number of companies under government supervision to eliminate financial consumer harm such as high interest rates and aggressive debt collection. A financial authority official said, "It would be good if raising the capital requirement strengthens loan businesses, but the number of companies managed within the system may decrease, so we need to approach this carefully."

The current view in the financial industry toward the National Assembly is that "a good system does not always produce good results." This was also the case with the recent amendment to the Loan Business Act and the heated debate over adjusting the legal maximum interest rate from the second half of last year to early this year.

Despite loan interest rates rising sharply, the legal maximum interest rate capped at 20% was not raised, causing secondary financial institutions to close their lending doors entirely. As a result, the number of low-credit borrowers pushed outside the formal financial system increased. The Korea Development Institute (KDI) released a study showing that under the capped legal maximum interest rate, when funding costs rose by 2 percentage points from late 2021 to June 2022, approximately 692,000 borrowers who could have obtained credit loans from secondary financial institutions at the end of 2021 were unable to do so.

Although the government and industry requested the National Assembly to raise the legal maximum interest rate, the Assembly, fearing public backlash, firmly rejected it. A secondary financial institution official said, "The National Assembly is not seeing reality clearly. The intention is good, but financial regulations that cause even greater side effects must be stopped."