Friday 22 August 2014

A Policy A Day: Microfinance Loan Scheme

In the lead-up to the election, we are going to examine one policy per (working) day. We've selected policies to be as balanced as possible across a range of policy areas and across the political parties. The idea is to explain the background, analyse the policy to investigate the pros and cons, and give a verdict on the policy at the end. Inevitably, some opinion will make its way in and we make no apology for that - after all, we're voters too. Also, I say 'we' because this series will feature some guest posts from other young people, to share their thoughts and ideas as well. A list of all the articles is available hereEnjoy!

Today's policy comes from the National Party. Paula Bennett announced on 16 May 2014 that the government is looking to assist community-based organisations in the provision of low or no-interest loans to people with unsustainably high debt or who cannot access affordable credit. The policy can be summarised as:
- Microfinance Loan Scheme for underprivileged and low-income individuals

In 2012, the Children's Commissioner created a group of experts to look at poverty in New Zealand. Unsurprisingly, they found that debt was one of the biggest drivers of poverty, yet we as a country are not doing enough to address the problem. The Expert Advisory Group on Solutions to Child Poverty returned with many recommendations, one of which was introducing low-interest loans to undercut "loan sharks". From the report:

"Many New Zealand families have some form of debt, such as a mortgage or credit card debit. Fewer families experience problem debt, where debt repayment becomes unmanageable and leads to financial strain. Children living in families with problem debt have less money to meet their essential needs, including food, clothing, heating, transport and school-related expenses."

From the NZ Herald article at the time:
"Expert group co-chairman Dr Jonathan Boston said the idea was inspired by an Australian scheme run by a charity, Good Shepherd Microfinance, using capital from the National Australia Bank (NAB) to lend to low-income families to buy essential household items at no interest, or cars and other items at low interest."

There are a few schemes already in existence in New Zealand, such as the Nga Tangata Microfinance Trust funded by Kiwibank. However, loan sharks still operate in many places, taking advantage of individuals who need money quickly and can't get it from friends/family or banks. People may have bad credit scores due to unpaid bills, or might be unable to provide collateral/security. Loan sharks often rely on low levels of education so that people don't read the fine print, and may not fully understand what they're getting themselves into. The price of getting money in this way is typically extortionately high interest rates, reportedly as high as 500% (per annum). Anecdotal evidence includes a man who bought a car for $9,000, expecting his total repayments including interest to be $11,000, but ultimately faced a total bill of $21,000. There are many other stories of shocking exploitation like this across the country.

Analysis of the Policy
The idea behind the policy is for the government to either create a programme itself or work with community-based organisation to provide loans to individuals when they are in financial hardship. The government is able to borrow money at a lower rate than most individuals, but regardless they would be able to provide the loans at an interest rate far lower than the loan sharks. In a perfect free market economy, this should price the loan sharks out of the market, as individuals should always choose the cheaper service. In many microfinance schemes, applicants have to go through an interview process to assess whether they need the money and to discuss their ability to pay the money back. Importantly, because these schemes are generally attached to social community organisations, the applicant and their family is likely to receive more knowledgeable support from social workers and volunteers. The government has a strong role in providing social welfare support, and microfinance schemes are a relatively low-risk method of helping people help themselves with a loan rather than a handout.

However, the policy feels like a solution that takes a "well if [bad thing] is going to happen anyway, at least it should be safe and controlled" approach. For some difficult social problems that approach is better than doing nothing, but it is like a panadol; it doesn't address the root issues that cause the bad thing to happen. Loan sharks exist because a profitable environment exists for them to operate in. Changing that environment is critical to resolving the true causes of the problem.

Even if the government is able to introduce a new entrant to the market that is able to take some customers away from the loan sharks, the loan sharks will continue to exist. Imperfect information and inequitable access to information will keep the loan sharks in the market, and the government should do more to stop their actions. The government has the power to regulate and restrict the types of exploitative and predatory practices used by loan sharks. For example, ridiculously high interest rates as high as 500% a year and unreasonable administration fees as high as $400 can be legislated against with caps (such as interest rate caps) if the government is willing to crack down on these operators. The Credit Contracts and Financial Services Law Reform Bill was passed in May, which included provisions that "put the onus on lenders to disclose full details of interest or fees and ensure borrowers can meet their repayment requirements," but this does not go far enough to protect vulnerable members of our society from exploitation.

However, such regulation goes against the interests of the many high-value donors to political parties who prefer the status quo, and the political will to enact harsh restrictions that puts people out of business is low. There are arguments that banning loan sharks outright would inadvertently ban or affect other types of more legitimate financial activity, and limits the ability of the "free market" to operate smoothly. In theory, individuals should be given choices, and if they choose to go to a loan shark then the free market should reward or punish them as a consequence of that choice. However, loan sharks give the entire financial industry a bad reputation, and ostensibly it would be a good idea for the legitimate and big players to back such regulation so that they can be seen to be more trustworthy. Unfortunately, it appears that profits are more attractive than morals.

Verdict: A policy with good intentions that will likely help some people, but doesn't address the root causes that allow loan sharks to operate. More significant and effective action could be taken to achieve a stronger outcome. The policy is still a good incremental step though.

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