A new wave of legislators in Congress have proposed bills that would impose government caps on fees and interest for credit cards and consumer loans. While perhaps they might be well intentioned, if enacted, these bills would harm consumers.
They especially hurt poorer Americans and will cause lower-income consumers to be pushed out of the banking system into shadowy black markets, where they risk exploitation.
Interest rate caps end up hurting borrowers with large debt burdens because they reduce their access to credit. This can create a negative spiral effect, including increased loan defaults and restricted access to emergency credit.
In March 2021, Illinois enacted a 36% interest rate cap. As a result, by 2024, lender licenses decreased by 64%, meaning fewer financial choices for fewer borrowers.
Researchers with the Federal Reserve System’s Board of Governors and two universities in Mississippi hypothesized that Illinois’ move would cut the credit availability for higher-risk borrowers. This proved correct as these borrowers—more likely to be minorites, women, and low-income people—struggled to improve their financial lives after the Illinois law took effect.
These economists’ paper, titled “Credit for me but not for thee,” compared results from Illinois with a control group in a neighboring state, Missouri, which didn’t impose this type of interest-rate cap.
They found “that the interest-rate cap decreased the number of loans to subprime borrowers by 44 percent.” This means fewer poor families are able to solve their credit needs. Most borrowers reported to the researchers “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.”
Credit cards are powerful vehicles for financial inclusion in the United States. They are highly regulated financial products, and by removing access to them, families are forced to tap into other markets, including pawn shops and off-the-books loans (which can be very unstable and with far higher interest rates than credit cards or other more regulated products) and other methods to fulfill their needs.
Even the embattled Consumer Financial Protection Bureau admitted that credit cards are the most effective way that “credit invisibles” become credit visible in America. This means people who are vulnerable and living on society’s margins, because they establish a credit history, are eventually able to qualify for auto loans, home loans, and other important lending products.
It’s no wonder that residents are leaving Illinois for other states. Another Illinoisan left every 9 minutes and 21 seconds from July 2023 to June 2024, according to the Illinois Policy Institute. Let’s hope D.C. lawmakers can heed the lessons from the Land of Lincoln and avoid exporting these bad policies nationwide.