[The Editors' Verdict] Lowering the Statutory Maximum Interest Rate Is Impossible

Discussions about lowering the statutory maximum interest rate are heard here and there. The intention is good. It seems aimed at enabling borrowers to consume without suffering, thereby boosting economic growth. However, in economics, good intentions or popularity do not always lead to good outcomes. In fact, such policies are more likely to produce effects opposite to their intentions.

First, the statutory maximum interest rate should be kept at the current 24%, and the pace of reduction should rather be slowed down. Based on 2017 data, low-credit borrowers were defined as grades 8 to 10, considering non-bank lenders mainly used by low-credit borrowers. When the maximum interest rate was lowered to 39% in June 2011, the number of new loans to low-credit borrowers significantly decreased. This was because the period of maximum interest rate reduction lasted until March 2014, allowing financial institutions and borrowers to anticipate market conditions. Also, the rate was still above the financial institutions’ break-even point.

Subsequently, the maximum interest rate was lowered to 34.9% in April 2014 and 27.9% in 2016, but the decrease in the number of new borrowers among mid-credit (grades 4 to 7) and low-credit borrowers was not significant. This means mid- and low-credit borrowers either could not enter the new market or faced a higher probability of loan rejection.

In 2017, when the maximum interest rate was lowered to 24%, it was estimated that at least 240,000 and up to 590,000 low-credit borrowers were excluded from the market from the demand side, but considering the decrease in small-scale suppliers, the total number of excluded borrowers rose by an additional 350,000 to between 590,000 and 940,000. When considering only the demand side focusing on new borrowers in 2017, a 1 percentage point decrease in the maximum interest rate led to a 2.132% increase in high-credit borrowers and a 3.398% decrease in low-credit borrowers. After the 24% rate was applied from February 2018, the number of borrowers in the loan business decreased by 814,000 in 2018 alone, and the credit grades eligible for new loans increased.

Generally, when financial companies calculate risk, default rates increase exponentially, so a 1 percentage point decrease in the statutory maximum interest rate results in a much larger impact than about 210,000 people. For example, as of the end of 2018, the default rate for grade 1 was 0.06%, but for grade 4 it was 0.57%, grade 6 was 1.91%, grade 7 was 7%, grade 8 was 11.07%, and grade 10 was 37.04%.

Also, from the end of 2016 to the end of 2019, the number of people in grade 1 increased from 10.02 million to 13.13 million, grade 2 from 7.78 million to 8.25 million, and grade 3 from 3.43 million to 3.51 million, while grade 7 decreased from 1.43 million to 950,000, grade 8 from 1.27 million to 1.1 million, grade 9 from 1.33 million to 1.05 million, and grade 10 increased from 370,000 to 440,000. The total number of people with credit grades increased from 44.7 million in 2016 to 46.52 million.

Therefore, if the current statutory maximum interest rate of 24% is lowered by 1 percentage point, even if loans become available from grade 7 (the average grade in the loan business) to grade 6, some of the 5.14 million people will turn to private loans. Assuming only about 50% shift to illegal private loans, multiplying by their average private loan amount of 12.55 million KRW per person results in about 26 trillion KRW. This part is currently being addressed by the formal financial sector.

The maximum interest rates in major countries such as the United States, the United Kingdom, Germany, France, and Singapore are much higher than in Korea. Exceptionally, Japan revised its Money Lending Business Act in 2006, lowering the interest rate ceiling to 15-20% annually, but the consumer finance market shrank by about 70%, from 20.9 trillion yen to 6.2 trillion yen, and the number of companies dropped from about 30,000 to around 2,000 by 2015.

Large-scale consumer finance companies and market oligopolization progressed, and a balloon effect occurred massively with the expansion of illegal private loan markets charging up to 2,000% annual interest. This has contributed to the withdrawal of secondary financial institutions and small financial institutions from the market during low-interest and prolonged recession periods, with illegal loan companies linked to organized crime groups filling the void.

Is a benevolent loan policy good for new borrowers? High-credit borrowers who have been repaying loans well benefit from lower loan interest by borrowing again.

On the other hand, as the statutory maximum interest rate is lowered, the eligible loan grades rise, forcing mid- and low-credit borrowers or young people without credit history to give up on financial institution loans.

In other words, the rich-get-richer and poor-get-poorer phenomenon in credit grades becomes more pronounced. The policy initially implemented to lower loan interest rates ends up reducing interest more for existing borrowers while pushing new or low-income entrants toward private loans outside the formal financial market.

Kim Sangbong, Professor of Economics, Hansung University

This content was produced with the assistance of AI translation services.