Is Lowering the Legal Maximum Interest Rate an Effective Policy?

Recently, there has been a political move in South Korea to lower the legal maximum interest rate from 20% to 15%. Although this change aims to protect financially vulnerable groups,

Recently, there has been a political move in South Korea to lower the legal maximum interest rate from 20% to 15%. Although this change aims to protect financially vulnerable groups, there is ongoing debate over its effectiveness. This article will explore the background of lowering the legal maximum interest rate, the backlash from the financial industry, and alternative proposals such as linking the rate to market interest rates and expanding policy financing.

1. Background and Current Status of the Legal Maximum Interest Rate Reduction

Recently, Representative Seo Young-kyo of the Democratic Party of Korea proposed amendments to the Interest Rate Limitation Act and the Loan Business Act, which aim to lower the legal maximum interest rate to 15%. The intention behind these changes is to prevent financially vulnerable groups from suffering under high interest rates. In fact, Lee Jae-myung, the leader of the Democratic Party, previously suggested an appropriate range for the legal maximum interest rate between 11.3% and 15% during his tenure as the Governor of Gyeonggi Province in 2021.

Under the current law, unregistered lenders cannot charge interest exceeding 25% annually, while registered lenders and credit financial institutions are capped at 27.9%. In 2018 and 2021, the Moon Jae-in administration lowered the legal maximum interest rate to 24% and 20%, respectively. The proposed amendment aims to further unify the maximum interest rate at 15%.

2. Concerns and Realistic Worries from the Financial Industry

However, both the financial industry and the secondary financial sector have expressed strong concerns about this proposed rate cut. For example, the mid-interest rate loans offered by savings banks are currently set between 11% and 17%, depending on the customer's credit rating, with some loans for lower credit scores reaching up to 18.59%. If the legal maximum interest rate is reduced to 15%, savings banks could also face negative margins.

The lending industry has already been facing profitability issues, leading many companies to either close down or drastically reduce their loan offerings. The number of registered lending companies dropped from 8,775 in June 2022 to 8,597 by the end of 2023, while the amount of credit loans issued by lending companies fell from 12.7 trillion KRW in 2018 to 4.7 trillion KRW in 2023, more than halving in volume. In this context, further lowering the legal maximum interest rate could threaten the very survival of many lending companies.

3. Alternative Proposals: Linking to Market Interest Rates and Expanding Policy Financing

Experts suggest that instead of lowering the legal maximum interest rate, it would be more realistic to link it to market interest rates. Professor Suh Ji-yong from Sangmyung University's Business School argues, "The legal maximum interest rate is not the same as the loan interest rate; it should be flexible and move in tandem with market interest rates." He also advises that rather than lowering the legal maximum interest rate, it should be restored to 24%, while the government should support financially vulnerable groups through "payment guarantees" to reduce high-risk borrowers.

The Korea Development Institute (KDI) also points out that "if the legal maximum interest rate remains fixed despite rising funding costs, it could restrict refinancing options for vulnerable households." Therefore, KDI emphasizes the need to link the legal maximum interest rate to market rates to improve financially vulnerable groups' access to the financial market.

While the intention behind lowering the legal maximum interest rate is to protect financially vulnerable groups, it could have the unintended consequence of restricting their access to finance even further. Policies that do not reflect market realities can end up placing a greater burden on the very people they are meant to help. Thus, there is a need to adjust the policy to link the legal maximum interest rate with market rates and to expand practical policy financing measures by the government.

To truly protect financially vulnerable groups, a careful approach that takes into account both the effectiveness and the reality of the policy is crucial.