Financial Inclusion without Finance? The Misguided Quest to Limit Choice in Consumer Credit

consumer credit, consumer loans, financial inclusion, payday lending, student loans
consumer credit, consumer loans, student loans, financial inclusion, payday lending
Jeremy Bentham

On October 21, I had the pleasure to give the research keynote address at the annual conference of the Financial Services Centers of America (FiSCA) in Miami. Below are my remarks, in which I critique some policymakers' attempts to promote financial inclusion by restricting consumer choice and giving the government a larger role in credit allocation. In light of historical experience in the U.S. and elsewhere, I offered market competition as a more effective policy to ensure all Americans can achieve financial security.


"The legislator, who knows nothing, nor can know any thing, of any one of [the borrower’s] circumstances, who knows nothing at all about the matter, comes and says to him—'It signifies nothing; you shall not have the money: for it would be doing you a mischief to let you borrow it upon such terms.'—And this out of prudence and loving-kindness!—There may be worse cruelty: but can there be greater folly?"
Jeremy Bentham, "Defense of Usury," 1787


Thank you for the opportunity to speak to you this morning.

Winston Churchill is said to have complained that two economists in a room could have as many as three opinions.[1] But there are a few matters on which economists have managed to reach a near-universal agreement. One is that price ceilings, limiting how much suppliers can charge, cause shortages. Another is that restricting production volume raises prices. Both interventions generally make consumers worse off.

This professional consensus notwithstanding, financial regulators at the state and federal level spend much of their time and manpower evaluating new proposals for limiting interest rates and reducing the volume of consumer loans. For example, the CFPB expected its 2017 Payday Rule to shrink the market for payday loans by between 62 and 68 percent.[2] On the legislative side, bills currently before the House and Senate would cap loan interest rates, including most charges, at 36 percent.[3] Another bill, co-sponsored by Senator and Democratic presidential candidate Bernie Sanders and New York Congresswoman Alexandria Ocasio-Cortez, would institute an even more draconian interest rate cap of 15 percent.[4]

In addition, most states have usury ceilings of their own—often below 15 percent.[5] National banks and federally insured state-chartered banks enjoy federal preemption, which since the late 1970s has meant bank loans can avoid low state usury caps.[6] Nonbank lenders, on the other hand, rely on special regimes for small-dollar loans in the majority of states that impose such caps. As of mid-2019, 32 states allowed small-dollar loans at economically viable interest rates. That is, down from the 35 states that allowed these loans when the CFPB first issued its Payday Rule.[7] In 2019 alone, bans on payday loans in Colorado and Ohio have cut over 13 million U.S. adults off from this type of short-term liquidity.[8]

Living in Washington, D.C., it is easy to mistake progress at the federal regulatory level for progress on the aggregate of federal, state, and local levels. For the past two years, the consumer lending industry has had some respite from federal bureaucrats' zeal to eliminate it. The likely rescission of the Payday Rule's mandatory underwriting provisions will no doubt remove an immediate existential threat. But this victory masks a troubling structural trend whereby states are gradually limiting access to short-term loans among the most vulnerable households.

Despite the claims of the credit prohibitionists, this trend ignores the longstanding scientific consensus on interest-rate and other restrictions on credit. Researchers at the World Bank, hardly a mouthpiece for the payday industry, write that "caps set well below market levels can reduce overall credit supply."[9] Recent evidence from Chile, where legislation cut interest-rate caps on loans under $8,000 by 20 percentage points, suggests these restrictions reduced aggregate loan volume by 19 percent, and loan volume to riskier borrowers by 24 percent.[10]

The United Kingdom's 2015 interest-rate cap on high-cost short-term loans, which I have studied in detail, has caused both loan volume and the number of borrowers to drop by more than 50 percent.[11] Furthermore, the cap's impact on borrower access was not uniform across the income spectrum. Whereas before the cap came into effect, more than 50 percent of payday borrowers had monthly incomes below £1,250 ($1,600, or around $20,000 per year), only 35 percent fell below that threshold in 2015.[12] Low-income borrowers, in other words, bore the brunt of the cap’s impact on credit supply.

Figure 1. Distribution of UK Payday Borrowers by Monthly Income, 2013 to 2015

Source: Consumer Finance Association (UK), Social Market Foundation, 2016.

Despite profuse findings of the adverse effects of interest rate caps, the World Bank researchers note that as of 2018, 76 countries, accounting for 80 percent of global GDP, imposed similar restrictions on loan interest rates. Notably, thirty countries, most of them in the developing world, had either introduced new restrictions or tightened existing ones since 2011.[13] It seems as though tight controls on consumer credit are as universal as the economic consensus against them.

Figure 2. Countries in the World with Statutory Interest-Rate Caps

Source: World Bank, 2018.

What explains the discrepancy between the policies that careful consideration of the facts would recommend—which include, at the very least, not tightening lending restrictions any further—and the policies actually in place? In developing countries, political corruption and the pursuit of industrial policies that include subsidizing corporate debt capital probably play a significant role. But in America, the issue has more to do with lawmakers' conviction that good outcomes can be legislated into existence. A quote from Representative Ocasio-Cortez and Senator Sanders as they introduced their 15-percent bill reveals this common conceit:

If we are going to create a financial system that works for all Americans, we have got to stop financial institutions from charging outrageous interest rates and fees.[14]

The Congresswoman and Senator see "creating a financial system" as within both their legislative remit and practical reach as policymakers. They also view prohibition as a suitable policy for expanding access to credit. According to this view, it is preferable to have fewer options that only meet the needs and financial positions of some consumers, so long as those options are cheaper. Market-replacing regulation that picks the products consumers should be allowed to choose from is preferable to market-reinforcing regulation that seeks to maximize competition and choice.[15]

Unfortunately, such prohibitionism is popular in Congress. When I testified before the House Financial Services Committee last April, another freshman member, Representative Rashida Tlaib from Michigan, used language consistent with the market-replacing approach when responding to a witness' observation that payday credit is often the only option available to distressed borrowers:

I think government is about people, and it’s about us creating those options that are better than [payday loans] . . . It is our job to create those options for you.[16]

Tlaib’s view of the role of government, however well-intentioned, is a troubling one. Not only does it furnish legislators with virtually unlimited power to attempt to shape markets, direct taxpayer funds, and restrict consumer choice; it also does not work. The history of government intervention in the allocation of credit is an unhappy one. Two particularly concerning patterns emerge from historical experience.

The first is the government's irresistible temptation to pick winners and losers. For example, few people know today that "redlining," the systematic avoidance of lending in particular neighborhoods, was government policy before it became the government's policy to eliminate it.[17] The Home Owners' Loan Corporation, a New Deal-era government-sponsored enterprise (GSE) that purchased loans from banks and thrifts, issued maps for mortgage lenders to use when making loans.[18] Areas colored red, which were typically home to minorities and immigrants, were a no-no.

Figure 3. Government “Redlining” in 1940s Miami

Source: University of Richmond, 2019.

The second pattern is the government’s track record of poor risk management when it comes to credit allocation. For example, in its attempt to redress the long-standing wealth and homeownership gap between whites and minorities, the U.S. government from the early 1990s assigned Fannie Mae and Freddie Mac targets for the share of loans made to low-income and minority borrowers that they were required to purchase.[19] Because of Fannie and Freddie’s dominant role in the housing market, the affordable housing targets spurred a rapid decline in underwriting standards that contributed to the financial crisis' ten million home foreclosures.[20]

It is tempting to blame the failure of government in credit allocation on past mistakes that subsequent learning has inoculated against. But a glance at new legislative proposals is enough to persuade one otherwise. Consider Senator Kirsten Gillibrand’s Postal Banking Act, which would grant the U.S. Postal Service the authority to provide small-dollar loans at interest rates "not [to] exceed 101 percent of the Treasury 1 month constant maturity rate."[21] That rate, by the way, is currently 1.76 percent, putting the maximum annual rate on U.S. Postal loans at 1.78 percent – less than the Federal Reserve’s inflation target.[22] The interventionist agenda thus seems to shift erratically between attempts to prohibit options that cater to vulnerable consumers and attempts to create lossmaking, taxpayer-subsidized forms of credit.

It is interesting that many politicians' conception of affordable credit begins and ends with a loan's annual percentage rate. That is a mistake, not only because the APR is an imperfect measure of the cost of a loan to the borrower. In addition, the interest rate tells us little about the range of consequences a borrower may face if they take out the loan, which may be much less attractive for low-APR than high-APR loans.

Compare a payday loan to a federal student loan. By the APR criterion only, a payday loan seems much less advisable than a student loan. The payday lender charges fees that yield annualized interest in the three-digit range, while the interest rate on a student loan is somewhere between four and eight percent.[23] Yet an examination of other features in each loan advises against such a rush to judgement.

First, a student loan numbering in the tens of thousands of dollars is a bigger financial commitment than a payday loan. The loan term is much longer, making the dollar cost of the loan greater than that of a payday loan. For example, a $25,000 student loan on a standard ten-year repayment schedule at 6 percent APR has a total interest cost of $8,306. That’s 33 percent of loan principal – more than double the representative 15 percent fee for a payday loan.

In addition, student loan repayment performance affects the borrower’s credit score, unlike most payday credit. The borrower usually may not discharge the loan in bankruptcy. Furthermore, the misleading marketing of federal student loans as "financial aid," the impenetrable mire of income-based repayment programs, and the widespread myth that a college education always pays off arguably cloud rational decision-making for student borrowers. No wonder an escalating share find themselves unable to repay their loans.[24]

But a discussion of the ailing student loan market is beyond my scope today. What I want to illustrate is that few if any forms of credit are always better or more suitable to every borrower. The proper mechanism for determining whether some loan products really are worse is competition. Giving consumers the broadest possible choice among alternatives is certain to weed out those options that do not meet consumer needs. A regulatory approach that maximizes that choice and harnesses private intermediaries to help consumers navigate the features of each option is therefore market-reinforcing.[25]

In a heterogeneous credit market such as America's, the alternative market-replacing approach will invariably exclude some borrowers. More than eight million U.S. households do not own a bank account. Another 24 million use nonbank credit.[26] As of mid-2015, 45 million U.S. adults were "credit invisible."[27] Just last month, the New York Fed suggested millions more are "credit insecure," as they tend to use up their credit limit and have very low credit scores and a history of payment delinquencies.[28] Minorities, immigrants, and the young are disproportionately represented among the ranks of the "underbanked" and credit insecure.[29]

The credit needs of these people are different from those of prime and asset-rich borrowers, simply because they lack access to most of the options available to people with longstanding financial security. Yet regulators sometimes make it difficult or impossible for the market to offer alternatives that would provide the credit invisible or insecure a gateway to financial inclusion. No fewer than 21 of the 50 most credit insecure counties in America are in states that ban payday loans.[30] Furthermore, nine of those 17 states and the District of Columbia have "underbanked" rates at or above the national average.[31]

Figure 3. 21 of the 50 Most "Credit Insecure" Counties in America Are in Payday-Prohibitionist States

Source: Federal Reserve Bank of New York, 2019.

These states have a financial inclusion problem worse than the rest of the country. But their restrictive policy approach is not helping excluded borrowers achieve financial security, because the absence of higher-cost options does not increase the availability of lower-cost ones. If that were the case, the most prohibitionist jurisdictions would have the best financial inclusion outcomes in America. Yet five of the eight "credit-assured" states, the top performers in the New York Fed credit insecurity study, permit payday loans.[32] Indeed, two of those states, Utah and Wisconsin, have comparably liberal regulation.

Policymakers are vulnerable to the conceit that they can will financial inclusion into existence. This is the same conceit that sustains the belief that loans without underwriting and risk-based pricing can be viable. I call this school of thought "financial inclusion without finance," because it expects broad access to financial services can come without a broad set of options, and without the lender's due diligence on which rational allocation of capital depends.

While the status quo is undesirable, market-replacing policy is not the only, let alone the best, solution. Nor is it inevitable, although the direction of recent policies is cause for concern. More than a hundred years ago, Progressive reformers wrote the Uniform Small Loan Law to make small-dollar credit viable and drive loan sharks out of business.[33] The Law allowed licensed lenders to charge a maximum monthly rate of 3.5 percent on loans of up to $300 ($7,000 in today’s money). A 1923 review of early implementation efforts noted the then-widespread realization that, "[s]o long as a need exists for small loans, it will be met, and if the need cannot be met lawfully, the law will be evaded."[34]

The Uniform Small Loan Law was a qualified success. By 1944, 31 states had adopted a version of it.[35] A 1954 issue of the Duke University journal Law and Contemporary Problems celebrated the adopter states’ progress in tackling "the loan shark problem."[36] In an article for that issue, then-Attorney General and former Governor of Minnesota Joseph Burnquist crowed that his state's version of the Uniform Law had "solve[d] the loan shark problem."[37] A Nebraska state official penned another contribution with the title "Nebraska has no loan shark problem today."[38]

But problems remained. Restrictions on the lenders who could avail themselves of the Uniform Law caused banks and others to charge origination fees in order to circumvent state usury caps. This segmented the consumer credit market and prolonged legal uncertainty. Furthermore, loan sharks continued to pose a serious problem in some states, prompting then-Senator-elect Robert Kennedy to call for a relaxation of New York’s usury laws in 1964.[39] From the 1970s, Supreme Court decisions and legislative changes allowed the small-dollar consumer credit market to gradually expand.

The lesson from over a century of small-dollar loan legislation is that the tide can turn, for better or worse. The silver lining in the cloud of current prohibitionist proposals at the federal level is that they would jeopardize much of the market for revolving credit and higher-cost installment loans, as well as payday loans. The scope for demonstrating the crushing impact of credit restrictions on those who can least bear them is therefore all the greater.

In 1787, the British philosopher Jeremy Bentham wrote probably the most eloquent polemic against interest-rate restrictions. More than 230 years later, it sometimes seems we are rehashing the same arguments that Bentham was supposed to have put to bed. I began my remarks by quoting a British luminary, so let me close with a quip from one more: “There is no final victory, as there is no final defeat. There is just the same battle, to be fought over and over again.”[40] I am sure you will agree with me that this battle, to bring access to financial security to the least well-off in society, will always be worth fighting.

Thank you.



[1] The Richmond Fed’s Aaron Steelman reports Churchill’s quote as: “If you out two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions.” Steelman, “Why Do Economists and the Public Disagree?,” Econ Focus, First Quarter 2016, Federal Reserve Bank of Richmond. Available at

[2] 82 FR 221, 54817.

[3] S. 1230, “Protecting Consumers from Unreasonable Credit Rates Act of 2019,” 116th Congress (2019-2020). Available at

[4] H.R. 2930, “Loan Shark Prevention Act,” 116th Congress (2019-2020). Available at

[5] Credit Union National Association, “Guide to State Usury Laws,” June 2014. Available at

[6] Marquette Nat. Bank v. First of Omaha Svc. Corp., 439 U.S. 299 (1978). Available at

[7] 84 FR 4252, 4253-4254. As of late April 2019, Ohio no longer allowed payday loans.

[8] Author’s calculations using U.S. Census Bureau population data.

[9] Aurora Ferrari, Oliver Masetti, and Jiemin Ren, “Interest Rate Caps: The Theory and The Practice,” World Bank Policy Research Working Paper 8398, April 2018, 4. Available at

[10] José Ignacio Cuesta and Alberto Sepúlveda, “Price Regulation in Credit Markets: A Trade-off between Consumer Protection and Credit Access,” 3. Available at

[11] Financial Conduct Authority, “High-Cost Credit: Including Review of the High-Cost Short-Term Credit Price Cap," Feedback Statement FS 17/2, July 2017, 20. Available at; Consumer Finance Association (UK), “Impact of Regulation on High Cost Short Term Credit: How the Functioning of the HCSTC Market Has Evolved,” March 2017, 8. Available at

[12] Consumer Finance Association (UK), “A Modern Credit Revolution: Ana Analysis of the Short-Term Credit Market,” 2016, 12. Available at

[13] Ferrari et. al, “Interest Rate Caps,” 2.

[14] Bernie Sanders, “Senator Bernie Sanders’ and Representative Alexandria Ocasio-Cortez’s Plan to Stop Big Banks and Payday Lenders from Ripping Off Americans,” Medium, May 9, 2019. Available at

[15] Todd J. Zywicki, “Market-Reinforcing versus Market-Replacing Consumer Finance Regulation,” in Reframing Financial Regulation: Enhancing Stability and Protecting Consumers, eds. Hester Peirce and Benjamin Klutsey, Mercatus Center, 2016, 320-321: “Market-replacing regulatory strategies seek to limit choice and competition through prohibitions or restrictions on particular products and terms . . . A market-reinforcing regulatory strategy, by contrast, seeks to promote competition and choice so that consumers can find those products that they think are best for themselves.” Available at

[16] House Financial Services Committee Sub-Committee on Consumer Protection and Financial Institutions, Hearing on “Ending Debt Traps in the Payday and Small Dollar Credit Industry,” April 30, 2019, at 2:05:19. Available at

[17] For an in-depth analysis of the federal government’s pernicious role in the promotion and enforcement of lending discrimination, see Richard Rothstein, The Color of Law: A Forgotten History of How Our Government Segregated America (New York: Norton & Co., 2017).

[18] Researchers at the University of Richmond collected and digitized HOLC maps for many U.S. metropolitan areas. The maps are available at

[19] Peter J. Wallison, Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again (New York: Encounter, 2016), 128-134.

[20] William R. Emmons, “The End Is in Sight for the U.S. Foreclosure Crisis,” Federal Reserve Bank of St Louis, December 2, 2016. Available at

[21] S. 2755, “Postal Banking Act,” 115th Congress (2017-2018). Available at

[22] FRED Database, “1-Month Treasury Constant Maturity Rate,” Federal Reserve Bank of St. Louis. Accessed October 15, 2019. Available at

[23] Federal Student Aid, “Understand How Interest Is Calculated and What Fees Are Associated with Your Federal Student Loan,” U.S. Department of Education. Accessed October 16, 2019. Available at

[24] Judith Scott-Clayton, “The Looming Student Loan Default Crisis Is Worse than We Thought,” Evidence Speaks Reports, Vol. 2 No. 34, Brookings Institution, January 10, 2018, 4. Available at

[25] Zywicki, “Market- Reinforcing versus Market-Replacing Consumer Finance Regulation,” 335-337.

[26] Federal Deposit Insurance Corporation, “2017 FDIC National Survey of Unbanked and Underbanked Households,” October 2018, 1. Available at

[27] Consumer Financial Protection Bureau, “CFPB Data Point: Credit Invisibles,” May 2015, 6. Available at

[28] Federal Reserve Bank of New York, “Unequal Access to Credit: The Hidden Impact of Credit Constraints,” September 2019, 7-8. Available at

[29] FDIC, “2017 Survey,” 3; FRBNY, “Unequal Access to Credit,” 10.

[30] Author’s calculations using data from FRBNY, “Unequal Access to Credit,” 16.

[31] Author’s calculations using data from Federal Deposit Insurance Corporation, “FDIC National Survey of Unbanked and Underbanked Households: Technical Appendix,” October 2018, 11-12. Available at

[32] FRBNY, “Unequal Access to Credit,” 13.

[33] George G. Bogert, “The Future of Small Loan Legislation,” Chicago Law Review Vol. 12 No. 1 (December 1944), 4. Available at

[34] “The Uniform Small Loan Law,” Columbia Law Review Vol. 23 No. 5 (May 1923), 484. Available at

[35] Bogert, “The Future of Small Loan Legislation,” 4.

[36] Robert Kramer, ed., “The Loan Shark Problem Today,” Law and Contemporary Problems Vol. 19 No. 1 (Winter 1954). Available at

[37] J.A.A. Burnquist, “A Regulatory Small Loan Law Solves Loan Shark Problem,” Law and Contemporary Problems Vol. 19 No. 1 (Winter 1954), 29. Available at

[38] Harold Johnson, “Nebraska Has No Loan Shark Problem Today,” Law and Contemporary Problems Vol. 19 No. 1 (Winter 1954), 42. Available at

[39] Todd J. Zywicki, “The Sanders-AOC Protection for Loan Sharks Act,” Real Clear Policy, June 2, 2019. Available at

[40] Tony Benn, Letters to My Grandchildren: Lessons for the Future (London: Hutchinson, 2009).