Interest rate regulations lead to illegal lending

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Interest rate regulations lead to illegal lending


In the past decade, the Korean government has steadily lowered the maximum interest rate that lenders can charge for loans, and while some analysts say the move will benefit the market in the long run, it has also led to the proliferation of illegal lenders who charge abnormally high rates and ultimately burden the country’s most vulnerable borrowers.

Early last year, the government set the legal limit for loan interest at 27.9 percent. Just a decade earlier, the rate was as high as 60 percent.

Between March of last year and June of this year, the number of private lenders offering loans based on credit score has fallen to 49 nationwide from 79, according to recent data from the Consumer Loan Finance Association, a group representing lenders. Among the 30 lenders that stopped issuing credit-based loans, 17 closed their business entirely. Most of those affected by the fall were small and medium-sized lenders with capital less than 20 billion won ($17.9 million).

“The recent drop in the maximum rate forced most small and midsize private lenders to reduce the amount of credit-based loans they issue,” said the former head of a private lender that closed down in November last year.

The association’s data shows that the number of borrowers going to private lenders has decreased. The lower cap led private lenders to tighten their screening process, forcing more potential borrowers to be disqualified. Up until September 2015, 940,000 borrowers with a poor credit score - between 7 and 10, with 10 being the worst credit - took out loans from private lenders. This number fell to 840,000 by the end of last year.

Because many of these loan applicants have bad credit, many end up turning to illegal lenders or loan sharks who charge interest rates exceeding the legal limit. The Consumer Loan Finance Association reported that the number of borrowers resorting to illegal lenders jumped from 330,000 in 2015 to 430,000 in 2016.

The government is poised to further slash the maximum rate, all the way down to 20 percent over the next five years, according to President Moon Jae-in’s five-year plan for the economy announced earlier this month. His administration plans to start by first cutting the rate to 25 percent before the end of the year from the current 27.9 percent.

These conditions have led some private lenders to take extreme measures, including issuing illegal loans. The Seoul Metropolitan Government recently conducted inspections on private lenders in the city and found 50 were providing less-than-legitimate services. Some embezzled borrowers’ money, while others would charge them illegal “consulting” fees. The city suspended the operation of six lenders, deregistered one and requested law enforcement authorities to investigate three.

Although the lowered ceiling has expanded the number of illegal lenders, government officials believe the move will ultimately help the market in the long run.

“We may see some transitional pain right now, but we’ve seen from other parts of the world like in Japan that a fall in the legal rate has ended up helping the overall market,” an official from the Financial Supervisory Service, a government regulatory agency, said. “The fall of the interest rate in Japan [which stands at 20 percent right now], ended up eliminating some of the smaller private lenders, who compared to the major ones lacked expertise and financial capability to start with. Only major lenders with a solid financial base and business know-how will survive in the end, and that’s how it should be.”

But with vulnerable borrowers turning to desperate measures for loans, others are calling on the government to create measures to protect them. “The proposed policy lacks details on how it will support people with poor credit scores,” said Kim Sang-bong, a professor of economics at Hansung University.

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