The Paradoxical Case Against Interest Rate Caps for Microfinance – And: How FinTech and RegTech Resolve the Dilemma

37 Pages Posted: 11 May 2018

See all articles by Dirk A. Zetzsche

Dirk A. Zetzsche

Universite du Luxembourg - Faculty of Law, Economics and Finance; Heinrich Heine University Dusseldorf - Center for Business & Corporate Law (CBC)

Tsany Ratna Dewi

University of Luxembourg - Faculty of Law, Economics and Finance; ADA Chair in Financial Law (inclusive finance)

Date Written: April 17, 2018

Abstract

Since 2010 approximately 40 developing countries and transitional economies imposed interest rate caps. This article analyses the impact of these interest rate caps on microfinance institutions. Introducing the taxonomy of soft, mezzo and hard interest rate caps we take a stance against hard interest rate caps arguing that the downsides of such hard caps outweight the benefits.

Our article is structured as follows: In Pt. II we show that regulatory materials published in the context of cap implementation reveals four justifications for imposing interest rate caps, including consumer and client protection, fraud prevention and exploitation by deceptive credit providers, support for a particular strategic industry or sector, and combating anti-competitive behavior where the costs of credit exceed the actual cost of lending plus a reasonable profit margin.

In Pt. III. to V. we argue that these arguments do not justify the imposition of hard interest rate caps: In Pt. III. we challenge each of the four arguments, arguing that hard interest rate caps, as one-size-fits-all solutions are too blunt an instrument to distinguish between the different service levels and industry environments in which microfinance institutions operate. In Pt IV. we outline that hard interest rate caps prompt two unwanted consequences instead: increasing the importance of the informal credit sector, and furthering the microfinance institution's mission drift. In Pt. V. we also show that the comparison with Northern low-interest economies is flawed.

Drawing on financial and regulatory technologies we develop alternative solutions in Part VI. First, the most adequate way to reduce too high interest rates is furthering competition among all institutions that could provide credit. Rather than distinguishing between regulated banks, microfinance institutions and mobile money and lending providers all of these three groups constitute the respective credit market, and competition between the three branches of credit markets is, in principle, desirable, if the policy objective is competition on the merits. This requires the development of well function credit registers, disclosure of effective interest rates and the facilitation of digital financial services.

Pt. VII. concludes.

Keywords: Digital Financial Services, Access to Finance, Emerging Markets, Interest Rates, Interest Rate Cap, Financial Inclusion, Financial Regulation, Microfinance, FinTech, RegTech, Client Protection, Credit Register, Mobile Money Operators

JEL Classification: G18, G21, G23, G24. G28, G38, K29, N20, N24, O16

Suggested Citation

Zetzsche, Dirk Andreas and Dewi, Tsany Ratna, The Paradoxical Case Against Interest Rate Caps for Microfinance – And: How FinTech and RegTech Resolve the Dilemma (April 17, 2018). University of Luxembourg Law Working 2018-003. Available at SSRN: https://ssrn.com/abstract=3159202 or http://dx.doi.org/10.2139/ssrn.3159202

Dirk Andreas Zetzsche (Contact Author)

Universite du Luxembourg - Faculty of Law, Economics and Finance ( email )

Luxembourg, L-1511
Luxembourg

HOME PAGE: http://wwwen.uni.lu/recherche/fdef/research_unit_in_law/equipe/dirk_andreas_zetzsche

Heinrich Heine University Dusseldorf - Center for Business & Corporate Law (CBC) ( email )

Universitaetsstr. 1
D-40225 Düsseldorf
Germany
+49 211 81 15084 (Phone)
+49 211 81 11427 (Fax)

Tsany Ratna Dewi

University of Luxembourg - Faculty of Law, Economics and Finance ( email )

L-1511 Luxembourg
Luxembourg
(+352) 46 66 44 - 5404 (Phone)
(+352) 46 66 44 - 35404 (Fax)

HOME PAGE: http://https://wwwen.uni.lu/research/fdef/research_unit_in_law/people/tsany_ratna_dewi

ADA Chair in Financial Law (inclusive finance) ( email )

162a, avenue de la Faïencerie
Luxembourg-Limpertsberg, L-1511
Luxembourg

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