IPTO gives money lending business to organized crime!

Jamesfung SG

I recently learned from a source that works closely with the licensed money lending industry that the IPTO (the Singaporean government agency that regulates and licenses money lenders) intends to effectively end the practice of legal unsecured lending to Singaporeans earning less than $30,000 annually via new regulations which are to become effective June 1, 2012.

The new regulations state that the interest rate charged is to be capped at 20% “Effective Interest Rate” (“EIR”) and that no other fees may be charged to the borrower except:

1.) Late payment fees. 2.) Fees for varying the contract at the borrowers request 3.) Fees for dishonored cheques 4.) Fees for unsuccessful GIRO deductions 5.) Fees for early redemption of the loan or early termination of the contract 6.) Fees for legal costs incurred for the recovery of the loan

In other words, above and beyond 20% “EIR”, no additional money can be collected unless the borrower fails to honor the terms of the loan, requests a change to the contract or repays the loan early. Since the vast majority of borrowers are going to act in their own self-interest, clearly they will not change the contract or repay the loan early if it results in anything much more than an effective rate of 20% “EIR” over the lifetime of the loan except in very rare cases. Therefore we can conclude that, for all borrowers that honor the terms of their contract, money lenders will under no circumstances be able to receive more than 20% “EIR” on those loans. That leaves deadbeat borrowers who fail to honor the terms of their contract as the sole source of additional revenue above and beyond the 20% “EIR” on loans available to licensed money lenders. The problem with this, as anyone that has worked in the industry surely knows, is that once a borrower (particularly in the short-term, unsecured, subprime market) becomes delinquent in their payments, chances become significant that some or all of the principal will never be recovered, let alone the interest and any additional fees assessed for delinquency. The amount of additional revenue realized from various types of dishonor fees that are willingly repaid by delinquent borrowers will not even begin to cover the losses of those that fail to repay some or all of their principal.

To illustrate exactly how absurd a 20% “EIR” cap is on these types of loans let’s take a very simplified hypothetical example: A licensed money lender makes ten 3-month loans of $1,000 each at 20% interest p.a. “EIR” stated as specified by the IPTO with three equal monthly repayments. Then let’s also assume that the money lender experiences 10% bad debt rate (i.e. one of the ten borrowers fails to repay the loan). That lender will lose $722.53 on these 10 loans cumulatively, and that is without any consideration given to overhead, costs of processing and servicing the loan, marketing, the money lender’s own internal financing costs, etc. Even with only a 5% bad debt rate (i.e. one of the ten borrowers can only pay back half of the principle and none of the interest) our hypothetical money lender would lose $222.53 on these ten loans, again without any consideration given for expenses or internal financing costs. It turns out that if we assume the bad debt rate may be as high as 10%, which certainly is not an unreasonable assumption for this market, the amount of interest required for our hypothetical money lender just to break even, assuming they have no expenses or internal costs of financing is 89.2% “EIR”! That’s well over quadruple what the new interest rate cap of 20% “EIR” is to be!

The unfortunate nature of short-term, unsecured, subprime loans is that they are necessarily at very high rates of interest so that the borrowers that do repay their loans cover the losses associated with the borrowers that do not with enough money left over for a money lender to earn a reasonable profit. If this is not the case there is no motivation to be in the money lending business at all.

Clearly the industry can not profitably make short-term, unsecured loans to subprime borrowers at an interest rate of only 20% “EIR”. The IPTO’s new regulations effectively mean that short-term, unsecured lending to borrowers with less than $30,000 in annual income will become illegal as of June 1, 2012. That however, will not mean that this industry will go away, it will simply be pushed into the black market. As anyone that has studied economics knows, price controls do not, cannot and will never work and this new interest rate cap is effectively nothing more than a price control on low-income subprime credit. The people who stand to benefit the most from this incredibly bone-headed legislation are illegal black market money lenders or loan sharks, the very entities the IPTO is tasked with curtailing. Surely a greater gift could never be given to black market money lenders than these new regulations.