Interest rates are there for a reason

Since this is an economic debate, we believe that as an opposition we have a duty to clarify several things about the basics of economics since it was not done properly by the proposition. First, what determines interest rate? Reading government’s case one could get a false impression that evil bankers exploit consumers and charge as high interest rates as possible. Sure, conspiracies are fun, but this is very far from reality. In essence, interest rate reflects transfer of consumption possibilities over time. If you want to consume now although you do not have the wealth now, you have to borrow against your future income. In frictionless world, that would be it. Since there are risks involved in our world, there are premiums that have to be charged additionally. For instance, when a borrower can default, she will be charged a premium. Let’s take an example. As a lender, you want to have a real return of 5%. You lend 100 dollars for a person with no probability of default with 5% interest rate, because expect her to repay with 100% confidence – and in the end the interest rate will bear you 5% real return. However, if a person has a 50% probability of defaulting, you have to lend to her 100 dollars with 110% interest rate! Because 210 dollars taking into account the 50% probability to get them is exactly 105 dollars. Additionally, there could be other premiums – for example, for inflation or currency risk. If we take a look at current economic conditions, the interest rates are high because they reflect high liquidity risk. Banks hoard liquid assets, because they are afraid that too many borrowers will default, leaving the bank illiquid. So, risk is essential in determining the interest rate for a loan and even the proposition acknowledged that ("banks are ... a collection of self-interested bankers who make personal profit from giving out high-risk high-interest rate loans."). Now what ensures that bankers do not charge any arbitrary amount for their loans? Competition! Banks and other institutions compete very much against each other to offer the best possible deals for the customers – the deals which would still be profitable for them in the end and would cover their cost of capital. The most possible consequence of the cap on interest rates is loans not being given for people who would have more than 20% rate. On the side of the proposition there was an assertion that “Our policy will, at most, influence the SIZE of the loans and the frequency of BAD loans”. The assertion is completely out the blue and was not supported with any reasoning why it should influence only these things. And we have quite strong evidence to believe otherwise, and here’s why. You don’t have to be a genius to figure out that loans with very high interest rates are given for people who cannot report any source of income or accumulated wealth. Furthermore, these loans have very small notional amount, because when a customer defaults, the financial intermediary would still have some chances of recovering losses (because the notional amount was relatively small). Lending large sums of money with interest rate over 20% to people with no income and wealth is an economically disastrous decision and will never work out – for this reason nobody does that. So, let’s say there is a group of customers who possess a default risk that is reflected by 40% interest rate. It is still beneficial for the bank to lend, because while some people will default, others will pay back with 40% interest, and the profits generated will be enough to cover the cost of capital. Once you cap the rates to 20%, the return on the loans would not be sufficient so as to cover for the cost of capital when some people start defaulting. The proposition might claim that reducing the interest rates would decrease the risk of default. This would be just unsupported rhetoric – if lending at 20% would be also financially beneficial, it would have been made already due to fierce competition in the lending sector. We do not deny that there might be exceptional cases where the cap would only reduce the size of the loan (e.g. when the customer has quite a lot of assets), but taken at the face value, the cap would simply deny the loans to individuals.