The Case for Interest Rate Caps in Indonesia (Part 2)
Increasing financial inclusion is a hot topic in Indonesia. All sectors (public, private and non-profit) have critical roles to play in ensuring that consumers are educated and able to access products that will improve their qualities of life. To start, I’ll outline my proposal for an interest rate cap, and then, I’ll highlight additional areas where a multi-sectoral approach can create meaningful social impact.
As they like to say, the devil is in the details — this is certainly true for interest rate caps. Simply setting a law against usury is insufficient; if the cap is too high, then it is meaningless and consumers will continue to get the short end of the stick. If it is too low (Kenya in 2016), then capital flight occurs as lenders refuse to issue loans without commensurate reward and consumers are, again, left underbanked.
There’s no magic formula to determining an optimal interest rate cap. Regardless of its level, there will be detractors. Nonetheless, all should agree that the priority is in establishing an equilibrium that encourages a healthy business environment while also protecting the interests of the citizen.
I’ll follow the World Bank’s taxonomy, but as with any policy, I am aware that there are alternative permutations that can achieve the same ultimate objective.
Parameters for an interest rate cap
Scope: To be effective for all consumers, this policy must have a broad scope, covering all types of credit (micro credit, consumer credit, MSME credit, etc.). Without a broad scope, lenders would be able to expose loopholes to continue extorting consumers by simply re-packaging their products around the new restrictions.
Number of Ceilings: As a start, there should be only one ceiling, which serves to represent the maximum level that should be allowed nationwide. Of course, for less risky segments (eg. SME), a lower ceiling could also be enacted, though this is a lower priority since the objective is to ensure overall consumer protection.
Type: Two types of caps are common around the world: absolute (where a fixed nominal rate is set) or relative (where the cap is pegged to a benchmark rate). Per the World Bank, absolute caps are more often used in low or lower-middle income countries, while relative caps are frequently found in high or upper-middle income countries.
Frankly, there are legitimate arguments for using either type of cap. As of September 2018, Indonesian banks offer consumer loans at 11–12% per annum, per Bank of Indonesia data, and this could be used as a benchmark for a relative cap. Of course, this is a galaxy away from the 400%+ APR that payday lenders are currently charging in Indonesia.
For simplicity, I’ll follow the example of other countries in Indonesia’s income tier (currently classified as a lower-middle income country). Therefore, an absolute interest rate cap makes most sense at this time.
Fees: Often, lenders include additional fees and provisions to generate supplementary revenue (eg. administration, collections, monthly service, payment, etc.). These fees, if not included as part of the interest rate cap, will erode transparency and trust within the financial system, and undercut the entire purpose of setting a cap. Therefore, any interest rate cap must include all fees, so that an effective annual rate (APR) can be calculated for every loan.
Proposal
Given today’s lending environment in Indonesia, we need a nationwide, absolute lending cap of 130% APR, which approximates to 0.36% per day (inclusive of all fees). This level is set by evaluating both domestic interest rates of mortgages, vehicles, credit cards, unsecured cash loans (online & offline), and comparing against international standards.
This cap likely seems high to many of you, especially those from outside of Indonesia. However, this will prevent much of the anti-consumer behaviorthat OJK is trying to prevent, while also ensuring that good capital remains. Cost of capital is high in Indonesia (20%+ for P2P lenders), and the cost of credit (default losses) also remains stubbornly high. However, if a lender cannot establish a sustainable revenue model while charging 0.5% per day, then they have no business being in this industry. At the same time, this prevents customers from being exposed to usurious loans and entering a debt trap.
At the same time, there are additional features that can be included in a broader policy that will increase consumer protection and ensure that smart businesses are able to thrive. To name only a few:
- Transparency guidelines: Design a standardized format that all lenders must abide by in listing out the fees and conditions of the loan contract (similar to the Schumer Boxused for American credit cards)
- Financial literacy: launch consumer education campaigns to improve their ability to budget and save for the long-term, while also educating them on various types of available credit facilities
- Cost of funds reductions: permit lending companies to offer savings products to their customers so as to reduce the overall cost of borrowing
There’s certainly a lot more we can do to increase financial inclusion across Indonesia. We all have a part to play in ensuring that consumers are well-informed and receiving access to value-adding products. I’m looking forward to working with regulators, fellow lending companies and other partners in the industry to build a more inclusive Indonesia.
