I recently learned from a source that works closely with the licensed money lending industry that the IPTO (the Singaporean government agency that regulates and licenses money lenders) intends to effectively end the practice of legal unsecured lending to Singaporeans earning less than $30,000 annually via new regulations which are scheduled to go into effect as of June 1, 2012. The new regulations state that the interest rate charged is to be capped at 20% “Effective Interest Rate”(“EIR” see attachment EIR.jpg for an explanation of how “EIR” is calculated) and that no other fees may be charged to the borrower except: 1.) Late payment fees. 2.) Fees for varying the contract at the borrowers request 3.) Fees for dishonored cheques 4.) Fees for unsuccessful GIRO deductions 5.) Fees for early redemption of the loan or early termination of the contract 6.) Fees for legal costs incurred for the recovery of the loan In other words, above and beyond 20% “EIR”, no additional money can be collected unless the borrower fails to honor the terms of the loan, requests a change to the contract or repays the loan early. Since the vast majority of borrowers are going to act in their own self-interest, clearly they will not change the contract or repay the loan early if it results in anything much more than an effective rate of 20% “EIR” over the lifetime of the loan except in very rare cases. Therefore we can conclude that, for all borrowers that honor the terms of their contract, money lenders will under no circumstances be able to receive more than 20% “EIR” on those loans except in the rarest of cases. That leaves deadbeat borrowers who fail to honor the terms of their contract as the sole source of additional revenue above and beyond the 20% “EIR” allowed by law available to licensed money lenders. The problem with this, as anyone that has worked in the industry surely knows, is that once a borrower (particularly in the short-term, unsecured, subprime market) becomes delinquent in their payments, chances become significant that some or all of the principal will never be recovered, let alone the interest and any additional fees assessed for delinquency. The amount of additional revenue realized from various types of dishonor fees that are willingly repaid by delinquent borrowers will not even begin to cover the losses of those that fail to repay some or all of their principal. To illustrate exactly how absurd a 20% “EIR” cap is on these types of loans let’s take a very simplified hypothetical example: A licensed money lender makes ten 3-month loans of $1,000 each at 20% “EIR” with three equal monthly repayments. Then let’s also assume that the money lender experiences 10% bad debt rate (i.e. one of the ten borrowers fails to repay the loan completely). That lender will lose $722.53 on these 10 loans cumulatively, and that is without any consideration given to overhead, costs of processing and servicing the loan, marketing, the money lender’s own internal financing costs, etc. Even with only a 5% bad debt rate (i.e. one of the ten borrowers can only pay back half of the principle and none of the interest) our hypothetical money lender would lose $222.53 on these ten loans, again without any consideration given for expenses or internal financing costs. It turns out that if we assume the bad debt rate may be as high as 10%, which certainly is not an unreasonable assumption for this market, the amount of interest required for our hypothetical money lender just to break even, assuming they have no expenses or internal costs of financing is 89.2% “EIR”! That’s well over quadruple what the new interest rate cap of 20% “EIR” is to be! See the tables below that illustrate the numbers: Consider another, even simpler example: a $100 loan with one single payment after one month. The maximum allowable interest for this loan calculated using “EIR” is only $1.53. What business person in their right mind would risk losing $100 on an unsecured loan for the potential of earning just $1.53? Even if you found a person willing to take that risk, how could they be expected to comply with all the rules and regulations governing the contract that must be created for this loan, to obtain and maintain a moneylender’s license (it requires a $20,000 bond and a long, tedious application process), to maintain a place of business with a staff, etc. for only $1.53 income on the loan? Even with a 0% default rate, how could anyone earn money under those circumstances? Legal, small, short-term loans will simply become a thing of the past. The smaller and shorter term the loan the less likely anyone will want to offer it – it simply doesn’t make any business sense. The unfortunate reality of short-term, unsecured, subprime loans is that they are necessarily at very high rates of interest so that the borrowers that do repay their loans cover the losses associated with the borrowers that do not with enough money left over for a money lender to earn a reasonable profit. If this is not the case there is no motivation to be in the money lending business at all. Clearly the industry can not profitably make short-term, unsecured loans to subprime borrowers at an interest rate of only 20% “EIR”. The IPTO’s new regulations effectively mean that short-term, unsecured lending to borrowers with less than $30,000 in annual income will become illegal as of June 1, 2012. That however, will not mean that this industry will go away, it will simply be pushed into the black market. As anyone that has studied economics knows, price controls do not, cannot and will never work and this new interest rate cap is effectively nothing more than a price control on low-income subprime credit. The people who stand to benefit the most from this incredibly bone-headed legislation are illegal black market money lenders or loan sharks, the very entities the IPTO is tasked with curtailing. Surely a greater gift could never be given to black market money lenders than these new regulations. Banks too with their high interest credit cards which are not bound by the same rules as licensed moneylenders stand to potentially benefit from these new rules. The existing industry of nearly 250 licensed moneylender’s is fragmented and is incentivized to compete with one another by offering the lowest possible rates. We are not talking about a monopoly or oligopoly with just a few players that could easily conspire to keep rates (effectively prices) high, but nearly 250 small businesses competing with one another for consumer’s business. If there was not a demand for short-term, unsecured credit so many business could not possibly exist in the marketplace. Using rules and regulations to force this legal business to become unprofitable will only reduce the available supply and force it underground into the black market where interest rates will most certainly be higher due to less competition and the risks associated with illegal businesses. This is the exact opposite of what the IPTO claims they attempting to accomplish. Frequent attempts are made by politicians and the media to demonize licensed moneylenders as businesses that engage in predatory advertising and lending practices which seek to saddle consumers with more debt that they can handle. In many cases, nothing could be further from the truth as that is not in the best interest s of legitimate moneylenders acting in good faith. Legitimate moneylender’s want to lend money for a short period of time for a high rate of interest and to be repaid relatively quickly so that they can relend that money to the next borrower. If the borrower defaults, the moneylender may lose some or all of their principal. The strategy of saddling consumers with debt they can never be expected to pay off is much more analogous to the strategy employed by commercial banks with credit cards than it is to the short term high interest loans provided by licensed money lenders. In contrast, credit card issuers want consumers to accrue large balances making very small minimum payments. If one only makes the minimum payments on a credit card it will take years to pay off and the consumer will end up paying many times the original amount borrowed in interest. It is true that there are currently some unscrupulous moneylenders who may purposely grant aggressive loans (both in terms of principal amount and payment terms) in hopes that the borrower will not be able to honor the contract so that they can impose draconian penalties on the borrower, however, unspecified (and uncapped) “fees for varying the contract at the borrowers request” are still perfectly allowable even under the new rules. When is a borrower most likely to request changes to the contract? When they can no longer pay according to the original terms of course. In, fact, given the low cap on interest, this is the only conceivable strategy one could employ to make money as a licensed money lender under the new rules. Therefore, these new rules encourage the most disingenuous types of money lending rather than prevent it. The list of unintended consequences these new regulations will result in is long, however, one thing they certainly will not result in is higher availability of unsecured credit at lower interest rates for low income borrowers.

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Written by: James Fung Has been working closely with the money lending industry for the last 5 years.