EXCESS DEMAND, UNDERCAPITALIZATION, AND THE TRUE INTEREST RATE FOR CREDIT UNION LOANS IN UNORGANIZED MONEY MARKETS

Abstract

MOST CREDIT UNIONS are patterned after the CUNA** model in which members pool their savings and in turn lend to fellow members at a nominal interest rate not to exceed 12 % per annum. Any residual over costs which results from lending operations may be distributed as dividends or interest rebates. No limit is placed on rebates, while a maximum of 6% is generally set on the dividend rate. In the organized money markets of the industrialized countries, the traditional interest ceilings are generally high enough, in relation to competing market rates, so that the dividend and loan rates can serve to equilibrate supply and demand for loanable funds. If idle funds begin to accumulate, the real interest rate on loans can be reduced below the nominal rate by granting interest rebates. By the same token, the dividend rate can be adjusted, within the legal limit, to attract or discourage additional loan capital. However, in unorganized money markets, where competing market interest rates have been estimated to average between 24% and 36%o per annum, [Wai ( 1957) ], the traditional interest constraints on credit union loans and dividends effectively destroy the market equilibrating function of the nominal interest rate. Under these conditions, demand for loanable funds tends perpetually to exceed supply. Two very important problems stem from this failure of the price mechanism; one is, of course, the loan allocation problem, and the other is the problem of raising initial loan capital. To meet these twin problems, credit unions in unorganized money markets have hit upon a simple device: a member's ability to borrow at the low nominal loan rate is made contingent upon his prior and continued saving in the credit union. This device has the dual advantage of encouraging members to save and of rationing scarce loan funds among competing loan applicants. In effect, it raises the real interest rate on loans above the nominal rate and thereby permits the price system to at least partially re-assume its allocative role. This effect can be illustrated graphically by use of a two-period paradigm of choice (see Diagram 1). The paradigm assumes a population of potential credit union members, each of whom possesses some endowment of both present and future goods. Potential member Fulano is one of this population. He currently holds, the combination of present and future goods represented