Bankable Frontier Weblog

The National Credit Bill continues to wind its way through the parliamentary process in South Africa. The background to this bill, which will transform the regulation of the entire consumer credit sector in the country, has been discussed previously in this blog. In the process of public hearings in mid-August 2005, reported in this Business Day article, the parliamentary committee is hearing all sorts of scare stories about its possible impact: the latest is that the bill will threaten the existence of hundreds of small payday-type lenders which currently operate legally under an exemption from the Usury Act. This exemption enables them to charge rates of anything from 10-25% per month.

What price the American Dream?

Reading the current complaints of an industry body representing small lenders in South Africa, I was taken back many decades, to 1917, and across many miles, to New York State. US historian Lendol Calder has produced a very fine piece of social history called Financing the American Dream, which tracks the development of consumer credit in the US in the 20^th Century. Reading the book earlier this summer left me with a strong sense of déjà vu with respect to the evolving situation in South Africa, and indeed other emerging markets today.

In the first two decades of this century, a pitched legislative and policy battle was fought in the US over how best to deal with the rising numbers of small loan companies. These companies made loans typically of $25 over 13 weeks, charging rates of anywhere between 20-300% p.a., despite a state Usury ceiling of 6% in New York at the time. They stayed in business only because the law was badly enforced. A much publicized study financed by the Russell Sage Foundation in 1907 found evidence that borrowing from loan sharks was pervasive, especially, but not only, among government employees and low level white collar workers. People in these groups borrowed to improve their standard of living as middle class aspirants, rather than mainly to finance emergency expenditure, as poorer people often had to. At the time, 90% of employees of the largest transportation company in New York were found to be making payments to loan sharks.

Headquarters of the Russell Sage Foundation in New York City, built at around the time of the developments in this post

Efforts to crowd out these lenders included the formation of so-called ‘remedial loan societies’ and other semi-philanthropic lenders such as the Provident Loan Society of NYC in 1894, which charged below market prices. However, Calder remarks that the efforts of these entities, which today we would call microfinance institutions, were a drop in the ocean of private credit demand: they neither drove rates down nor reached the neediest borrowers. Public education campaigns on the evils of money lenders (including the early film The Usurer’s Grip) also seemed to have little effect on demand.

What had a major effort on the price, terms and ultimately availability of consumer credit was a compromise, eventually enshrined in law: this was the agreement reached between the anti-loan shark brigade, led by the Russell Sage Foundation, and the more far-sighted and reputable of the ‘loan shark’ associations. The anti-brigade effectively recognized that high interest rates were a reality on small loans, and that it was better to legalize the sector and seek to improve it over time, than to leave it in the shadow of an unenforceable law; and the industry recognized that they had to accept a rate cap of some sort, rather than live in the twilight zone of the law. This compromise resulted in the passage of the Uniform Small Loan Law in three states in 1917 (and subsequently in many others). This law raised the usury cap level significantly (from 6% p.a. to 3.5% per month). Consequently, a large part of the small loan industry was legalized, under various conditions such as no fees on loans less than $300.

However, not all loan company associations supported or welcomed legalization on these terms: salary loan lenders in particular held out, using such artifices as claiming that they were ‘buying salary’, not in fact lending. But over time, these practices died out, as did the earlier philanthropic lenders, in part because of the much faster growth of the now legalized small loan companies. The widespread introduction of installment plans to buy cars in the 1920’s accelerated the already rapid growth of consumer lending. The US small loan industry, represented by its association AASLB, worked hard to rebrand the industry firstly as ‘industrial lenders’, rather than ‘consumption lenders’ as they had been known; and by the late 1920’s as ‘consumer lenders’,  which has since stuck. Some of the lenders became, literally, household names with nationwide distribution. Household Finance Corp, for example, started in 1878, was the first such lender to list publicly in 1928. By the late 1920’s, observing successes like these, the commercial banks led by National City had directly entered the burgeoning consumer credit business. Today, Household is a major credit card company, recently acquired by the HSBC Banking Group.

And, as they say, the rest is history: consumer credit is widely available to most people on a competitive basis in the US today. To be sure, abuses continue, especially with reckless lending, but the problem is no longer access. As history is being made in South Africa with the passage of the new consumer credit law, I hope that the compromises reached around the new legislation there will lay foundations for a sustainable credit sector. Only with sound foundations can the bankable frontier be pushed out further over time.