Tan Kin Lian's Blog: Cap on interest rate and bank charges

Sunday, November 15, 2009

Cap on interest rate and bank charges

Should the government set a cap on loan interest rate and other bank charges?

At one time, it was argued that these matters should be left to the free market. Consumers can make their choice and avoid the banks that have high charges. In reality, consumers are not aware about these charges. The ignorance allows the banks to make billions of dollars in high charges and fees.

The US Congress is now considering passing laws to make it mandatory for consumers to be informed about the charges and to opt in. Some people think that this does not go far enough, and that it is better for the Government to set limits on the interest rates and charges.

Many decades ago, there was a law to limit the interest rate that can be charged by money lenders. This law was necessary to prevent consumers from being exploited by money lenders. The same reasoning can be applied to the lending by banks, especially if they behave just as bad as the money lenders.

The general argument is that the level of interest rate should depend on the market and cannot be set by law. I do not agree with this argument, especially if we look at what has happened in many countries. It is better for the government to set these caps on fees and loan interest rate, and to revise them when necessary due to changes in the market conditions.

Tan Kin Lian

6 comments:

Anonymous said...: I think it is better to cap Inflation Rate (whether CPI or asset price) instead.; November 15, 2009 10:20 AM
Vincent Sear said...: I think that it's not easy to cap bank interest rates. The rates depend on economy and central bank monetary bank. However, I think that unfair charges should be stopped. For example, if the customer's account is insufficient, the bank should simply reject any further transaction, not allow the transaction and charge extra fee.; November 15, 2009 11:01 AM
Anonymous said...: Interest rates are already set by Governments.
This is done through treasury bills and bonds, which in turn influences the cost of borrowing money.
Allowing free market forces to determine the cost of borrowing is fundamental to capitalism.

The business is at liberty to charge what the market can bear.

Perhaps what can be done is to educate the public what is the cost of borrowing money.If people choose to pay more, than its their choice! Their ability to repay is left to the business to decide.

Regulating the advertisements may also help.; November 15, 2009 11:22 AM
wjsim said...: To get higher interest rates, there has to be higher production. In the future, supply of goods will be higher than present, hence present consumption will be more valuable. What can retirees do? Basically other than exposing themselves to more risk, they can't do anything as the government is robbing from their savings. Anyway...

The benefit of a cap on interest rate might be good in the short term, but what it really encourages is asset bubbles. There is no issue if the true interest rate as determined by the free market is lower than the cap. The problem comes when the true value of money isn't allowed to affect the market. This prompts people into profiting from the cheap money via black markets, such as illegal HDB subletting and simply driving up asset prices. There is no way the regulator can accurately set interest rates. Even if they do, aren't they redundant?

And due to political pressure, the regulating body (likely to be the government) will be reluctant to raise rates as it will burst the asset bubble and cause a "recession" (which is basically the solution to the problem). And they will look bad during elections no?

nah, they'll probably blame the free market :); November 15, 2009 3:21 PM
YZ said...: persistent low interest rate is a reason for this housing bubble in US (plus the easy administrative measures). It can be seen as subsidising this bubble. WJSIM is right that if we don allow int rate to rise, then bubbles are bound to form in some asset classes. The earlier the int rate rises, the milder the recession is.

It's very amusing to see tides of "blaming the free market" when precisely the failure to let free mkt run its course is the culprit, most of the time.

Setting price cap is a blunt tool that passes on problems to elsewhere, requiring domino of administrative corrections. And we're inching closer to massive bureaucracy to do central planning. The outcome of which has been witnessed throughout 20th century. To address cheating of customers, it's less costly to attack it head-on by mandatory sharing of info, raising awareness etc. than to intervene the free mkt pricing mechanism in a big way.; November 16, 2009 1:56 AM
Anonymous said...: Banks here create jobs therefore it's our govt's job to "protect" them to create more jobs for "FTs".; November 16, 2009 10:54 AM