Lifting Interest Rate Caps Lets Financial Markets Do Their Job

As interest rates are being raised as a countermeasure against inflation, market rates are also climbing. As signs of a global economic crisis emerge, financial instability is breaking out in various places, and there are even cases in which people’s lives are put at risk because they cannot secure funds. The problem is that the Interest Rate Limitation Act, which caps the legal maximum interest rate at 20%, is causing the financial market to lose its ability to function properly. The situation calls for lifting interest rate caps, even if only temporarily.

High interest rates affect people differently. For those who save and lend money, higher rates increase income. On the other hand, for those who borrow money, the cost of interest rises and the burden grows heavier. In a situation like the present, where inflation has become a serious social problem, it is clear that raising interest rates is unavoidable.

If interest rates have risen across the board, the maximum rate must rise accordingly for the financial market to play its proper role. Raising the 20% ceiling—set in line with the low-rate environment of the past—to reflect the current surge in interest rates is a measure that can help the economy overcome the crisis. It is also a way to minimize the damage caused by rigidity in finance.

During the 1997 foreign exchange crisis, the maximum interest rate was raised from 25% to 40%, and then, at the IMF’s request, the Interest Rate Limitation Act was abolished altogether. Thanks to the government’s swift response, the financial market was able to normalize and begin functioning again. With the enactment of the Loan Business Act, a wider variety of financial products also became possible.

Afterward, the political sphere revived the Interest Rate Limitation Act, once again restricting interest to a certain level on the grounds that high interest rates are harmful. This was the result of anti-market arguments gaining the upper hand by branding high interest rates as a social evil, even though the law is a harmful regulation that restricts financial transactions. But the Interest Rate Limitation Act is an excessive regulation that restricts transactions between creditors and debtors, and it causes real harm. Those pushed out of the formal financial system are left anxiously unable to obtain funds, and are driven into legal blind spots, wandering the back alleys outside the protection of the law.

Whatever one may think of them, it is normal for interest rates to change constantly. When market rates rise, that means people should spend more sparingly, reduce consumption, and lessen their debt burden. At the same time, it means investment should be made more carefully in areas with higher returns. In this way, interest rate volatility in the market affects consumption and investment and thus serves to regulate the circulation of the economy. Without such changes in interest rates, their signaling function for business fluctuations and investment is neutralized, and the financial market loses its sense of direction. It can no longer fulfill its proper role, and the damage to financial consumers grows. Moreover, if the flexibility of the interest rate function weakens, investment efficiency declines and the economy moves backward.

Politics that seeks popularity by treating high interest rates as a social evil has always existed throughout history. In the Middle Ages, interest itself was not recognized at all, and in countries influenced by Islamic culture, interest remains legally prohibited even today. Turkish President Erdoğan continues to cut interest rates, saying that interest is the root of all evil. In fact, Türkiye’s inflation rate has exceeded 80%, so this is a case of politics that does not even understand what the problem is.

The Korean government has also repeatedly lowered the maximum interest rate. It set the ceiling at 24%, down from 27.9%, and in March 2021 it forced it down to 20%. It is wrong to pursue one’s own political ambitions while disregarding whether the market is damaged and whether people in need of money are left wandering the streets.

People with low credit ratings are also citizens and financial consumers. They, too, must be able to borrow funds in the institutional financial market. Sacrificing them for politicians’ popularity infringes on the choice of citizens and consumers. The longer the high-interest-rate phenomenon persists, the greater the damage to citizens and consumers will inevitably become. The government and the political sphere need to act quickly, even if only temporarily, either by raising the maximum interest rate or abolishing the Interest Rate Limitation Act.

Sung-no Choi, President of the Center for Free Enterprise (CFE)

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Original title: 이자제한 풀어야 금융시장이 제 역할

Author: Sung-no Choi

Date: 2022-10-12

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=25004