A classic economic principle teaches that if you tax something, you get less of it, or if you subsidize something, you get more of it. Sadly, too often social policies are designed in this manner to tax productive economic activity and subsidize crippling poverty — harming the most vulnerable. Our latest example of this comes from America’s heartland: Illinois.
In March 2021, Illinois slapped an all-in interest-rate cap of 36 percent annually for loans under $40,000 from non-bank and non-credit-union lenders. These loans are sometimes called “installment loans” or a derogatory phrase, “payday loans.”
Although these types of financial services are sometimes criticized, people rely on them in a high-tech economy where otherwise they would depend on underground avenues like the black market.
Researchers with the Federal Reserve System’s Board of Governors and two universities in Mississippi hypothesized that Illinois’ move would slash the credit availability for high-risk borrowers. They were right, and the effects left these borrowers, often minority, low-income people, struggling. It was exactly opposite of the outcome promised by the progressive ideologues running the Land of Lincoln into an inhospitable business climate (it’s no wonder people are fleeing Illinois and other blue states for better-run red states).
These economic researchers compared the resulting data for Illinois with a control group from its neighboring state, Missouri, which doesn’t have this type of interest-rate cap.
They found “that the interest-rate cap decreased the number of loans to subprime borrowers by 44 percent and increased the average loan size to subprime borrowers by 40 percent.” So basically, fewer people were able to take out much larger loans. Sounds like a toxic recipe for economic headaches.
Just how did those headaches manifest? The researchers examined the negative life effects of this loss of credit access using an online survey of short-term, small-dollar-credit borrowers in Illinois.
Most borrowers reported that “they have been unable to borrow money when they needed it following the imposition of the interest-rate cap. Further, only 11 percent of the respondents answered that their financial well-being increased following the interest-rate cap, and 79 percent answered that they wanted the option to return to their previous lender.”
Thus, the Illinois interest-rate cap of 36 percent significantly decreased the availability of small-dollar credit, particularly to subprime borrowers, and worsened the financial well-being of many consumers.
Just who are these consumers? As I noted last summer, many of them are unbanked and underbanked Americans who are left vulnerable amid record inflation and financial regulatory policies that restrict access to non-traditional banking services, such as loans. While most Americans use banks for their monetary needs, the Financial Deposit Insurance Corporation (FDIC) estimated that 5.4 percent of U.S. households (about 7.1 million) were unbanked in 2019.
Non-Asian minorities, low-income households, less-educated households, young households, and households with disabled members are more likely than others to be unbanked, according to the FDIC. Barriers to accessing other financial resources, like those erected in Illinois, impact these groups the most. As we see in California and elsewhere, too often bad policy developed in progressive states are exported elsewhere, and Illinois’ type of installment loan rate cap is being considered by federal policymakers. However, instituting a national interest rate cap would prevent low-income Americans from accessing loans to pay the bills for necessities like water and electricity.
By limiting the choices of unbanked Americans, policymakers leave consumers with fewer options and potentially force them into riskier and costlier alternatives. Policymakers should pursue reforms such as supporting community banks, giving consumers the ability to choose which services suit their present needs.
Illinois’ interest rate cap on installment loans is a distortive policy that shifts consumers away from the productive economic activity needed to fuel Americans’ lives.