Rate Regulation in the Field of Consumer Credit. I

Abstract

E previous article traced the grow|ing skepticism with which writers 1 have regarded competition as an effective regulative force the small-loan field. What follows is an examination of the merits of such a position. The negative case for competition within aflat-rate structure.-Before being willing to abandon competition it is necessary not only to ascertain its merits but to weigh alternatives. Because administrative rate control represents the other extreme from competition, and because several states are already experimenting this direction, it is the alternative considered the discussion which follows. The merits of a graduated (two) rate structure, legislatively set, are touched upon later. The writer is willing to admit at the outset that competition has not operated with theoretical smoothness lowering aggregate rates and adjusting differential rates. Further, that should not be expected, since all actual markets contain imperfections. Only if the latter are very great must competition be supplanted, and what follows shows that there is little evidence that cash lending is unduly peculiar this respect. The cost (price) of making loans depends on three variables-quality of borrower, loan size, and lender efficiency. Since there is no way of dealing directly with differences lenders' personal abilities, lender efficiency may be considered largely a function of the size of the loan office. Of the three variables the first is the least subject to measurement and therefore is difficult to deal with administratively. No efforts have been made to do so. Few people have been bold enough to suggest that state or municipal governments should undertake to make .... small necessitous loans, the collectability of which depends larger measure on the judgment of the lender selecting his borrowers.66 The same conclusion holds a fortiori of any attempt by the state to control the selection of risks by private lenders; the separation of authority and financial responsibility would bring about an impossible situation. The conclusion is inescapable that in the final analysis, competition must be relied upon to determine the credit standards which will be applied under any rate structure.67 Probably because of its objectivity the size-of-loan factor has received greater legislative attention. It is not possible to say that all loans of the same size have the same cost unless, as is rarely true, all the borrowers question are equal risk. (Differences size of loan offices are abstracted from here.) A loan may be thought of as a combination of a given size and a given risk grade. A flat maximum rate designates an infinite number of these combinations as marginal, i.e., as loans which it is only just profitable to make. All combinations which either or both parts are better than marginal are more profitable at the maximum rate.