Dont Cap Interest Rates for Micro-Loans

In earlier blog posts here and here, I examined the overall merits of micro-loans as a mechanism for defeating poverty. My argument then was that micro-loans are useful especially reducing the coercion and extortion of loans sharks because they provide a structured way for poorer people to acquire credit and to make repayments. At the same time, it is clear that for all power in social transformation, it is not a panacea to poverty because of the fact that most creditors run similar businesses based on labor intensive activities.

One known feature of most micro-loans schemes is that the interest rates payable on the loans are sometimes higher than what obtains in the formal banking system. Meddlesome politicians in India have therefore chosen to intervene by arguing for a cap in the interest rates charged by micro-loans institutions. As this article in the Economist states, the populist argument is that these institutions exploit borrowers because of the interest rates. My libertarian orientation aside, I am wondering what these public officials think the alternative interest rates would be and whether it is even right to compare interest rates between conventional banks and institutions that provide micro-loans.

Granted that insufficient understanding has never prevented many politicians from pronouncing themselves on an issue, one wonders why they would not urge their constituents to go for loans from the conventional banks that charge lower rates and leave micro-loans institutions alone. In my view, for as long as these loans are available as an alternative to loan sharks, many more households will opt for them.