But interest rate caps, usury laws by another name, are among the most studied and most consistently disappointing forms of economic regulation. Across countries, the evidence points in the same direction: When governments cap interest rates below market-clearing levels, credit does not become cheaper in any meaningful sense. It becomes scarcer, less transparent and more distorted.
An interest rate is the price of borrowing, and like any price it reflects underlying costs. For credit cards, those costs include funding, servicing, fraud, compliance, capital requirements and default risk. A borrower with a higher probability of default must be charged a higher rate for lending to make sense at all.
The World Bank puts the point bluntly: If interest rate caps are set so low that lenders cannot cover their costs and earn a risk-adjusted return, lending simply becomes uneconomic. The relevant question is not whether banks could earn less on some accounts, but whether entire segments of borrowers can be served at the capped rate.
For a large share of credit card users—especially younger borrowers, lower-income households and those with thinner or riskier credit histories—the answer is no.
How Credit Card Issuers Will Adjust
When interest rate caps bind lenders’ behavior, lenders do not passively accept lower returns. They adjust along multiple margins, many of which are not fully visible to consumers and are hard to regulate.
1. Reduced Access and Tighter Underwriting
The most obvious response to an interest rate cap is credit rationing. Decades of research show that credit supply is highly sensitive to price restrictions. When rates are capped, issuers tighten approval standards, reduce credit limits or stop offering products altogether to riskier borrowers.
This reduction in access is not evenly distributed. It falls disproportionately on borrowers with lower credit scores, unstable income or limited credit histories—the very consumers the policy is meant to help.
2. Higher Fees and Back-End Charges
If only interest rates are capped, issuers can and will shift costs elsewhere. Lenders frequently respond by increasing noninterest fees, including annual fees, late fees, balance transfer fees, foreign transaction fees and penalty charges.
Some of these fees are easier for consumers to avoid than interest; many are not. The overall cost of borrowing does not necessarily fall, but it becomes less transparent and harder to compare across products, particularly for consumers with limited financial literacy.
3. Weaker Rewards and Less Generous Benefits
Credit card rewards—cash back, airline miles, points, purchase protections—are not free. They are financed largely by interest income from revolving balances and interchange revenue.
A binding interest rate cap would put pressure on that revenue stream. Issuers would respond by:
- Reducing cash-back percentages
- Devaluing points and miles
- Raising redemption thresholds
- Eliminating ancillary benefits such as extended warranties or travel insurance
These changes are less politically visible than higher APRs, but they represent a real reduction in consumer surplus, especially for middle-income households who pay off balances intermittently but value rewards.
4. Product Simplification and Fewer Options
Risk-based pricing allows issuers to offer a wide range of products tailored to different borrowers. Rate caps compress that range. Cards designed for subprime or near-prime consumers become unviable, leaving a smaller, more standardized set of products aimed at safer borrowers.
Evidence from Countries That Have Tried This Before
Chile: Credit Caps Lowered Access
In 2013, Chile reduced the maximum legal interest rate on consumer loans from 54% to 36%. A 2019 study by Carlos Madeira in the Journal of Banking & Finance used matched household and bank data to estimate the impact.
The findings are clear:
- Nearly 10% of borrowers were excluded from bank credit
- Credit access fell sharply for borrowers whose risk-adjusted rates were just above the cap
- The negative effects were strongest for younger, less educated and poorer households
- The policy did not lower borrowing costs for these groups. It simply removed them from the market.
Colombia: Higher Caps, More Access
Colombia provides a useful contrast. In 2007, the government raised the interest rate ceiling for microcredit loans while keeping other caps unchanged. Using a difference-in-differences design and the full credit registry, researchers found that higher allowable rates:
- Increased new microcredit lending
- Increased new loans by 4.5% for every percentage-point increase in the cap,
- Expanded total loan portfolios
- Reduced average loan size and maturity, improving borrower-loan matching
- Allowing higher interest rates expanded access to credit, whereas capping them had previously constrained it.
When the U.K. introduced a cap on high-cost short-term credit in 2015, acceptance rates at the final stage of loan applications fell sharply, from around 50% to 30% within a year.
The Financial Conduct Authority anticipated a decline of 11% in loan volume and a 21% drop in the number of borrowers. The actual declines resulting from the interest rate cap were 56% and 53% respectively.
Rejected applicants were disproportionately younger, poorer and more likely to be unemployed. The cap reduced lending volume without eliminating demand.
When formal credit becomes less available, demand does not disappear. Borrowers turn to alternatives: informal lenders, employer advances, overdrafts or illegal credit markets. These options are often more expensive, less transparent and less regulated.
Interest rate caps often push borrowers out of the formal financial system and into precisely the kinds of arrangements policymakers claim to oppose.
The Bottom Line
A 10% cap on credit card interest rates would not make credit broadly more affordable. It would reshuffle costs, restrict access, reduce rewards and narrow consumer choice. The headline APR would fall, but many households would be worse off, either excluded from credit entirely or paying more in less visible ways.
As my colleague Veronique de Rugy noted last month:
“The strange new alliance between democratic socialists and nationalist populists isn’t a sign of political healing. It’s a sign that people have lost their grip on basic economics. They’ve decided that markets can be bullied, risk forbidden and prices commanded into submission. But magical thinking still produces real-world shortages when put into practice.”
Usury laws are politically attractive because they focus on prices. But prices in credit markets coordinate risk. When policymakers override the prices, the risk adjustments do not disappear; they show up elsewhere, to the detriment of consumers.
Jack Salmon is a Research Fellow and Gibbs Scholar at the Mercatus Center at George Mason University, where he focuses on economic and fiscal policy, with an emphasis on federal budgets, taxation, economic growth, and institutional analysis.
Rod's Comment: Nothing Donald Trump proposes or does should surprise me anymore, and it doesn't. Donald Trump is an economic illiterate. I am somewhat surprised that more Republicans just accept whatever he proposes. They know better. This is the kind of policy one would expect from Elizabeth Warren or Bernie Sanders.
Top Stories
Posts
No comments:
Post a Comment