Are we making loan sharks bigger and richer at expense of poor?

There must be safeguards to prevent excessive lending, protect financial stability and ensure responsible lending practices. Regulation must also take into account the ground realities faced by ordinary people. A policy can look perfectly sound on paper but have a very different impact when it reaches the poorest segment of society 

With the introduction of the 70% Loan-to-Value (LTV) limit on gold loans, one has to ask whether the Government has fully considered the unintended consequences of this policy.

The regulated gold-loan industry has provided an important and legitimate source of credit for ordinary people, particularly those at the lower end of the income spectrum. By imposing a 70% LTV limit, the Government may unintentionally be taking away an avenue that was available to these consumers and pushing them towards unregulated moneylenders—the loan sharks operating on the streets.

For many poor families, the gold chain, bangle or other piece of jewellery received at a marriage ceremony may be one of the very few assets they possess. When an emergency arises—when there is no money to buy food, pay school expenses, meet medical bills or provide for the basic needs of their children—that small piece of family gold can be their only source of immediate financial support.

Previously, they had the option of taking that gold to a regulated financial institution and obtaining a loan at a reasonable and regulated rate of interest. It was a relatively safe and transparent way of meeting an urgent financial need.

Unfortunate reality 

The unfortunate reality is that many may have no choice but to turn to the unregulated moneylender down the road. Such lenders can charge extraordinarily high rates—sometimes around 10% a month. What may initially appear to be a simple solution to an immediate problem can quickly become a financial trap.

Ultimately, the borrower may not only lose the money but also lose the family gold itself—the chain or bangle that may have been handed down through generations or given to the woman at her marriage.

Are we, therefore, inadvertently creating a larger and more profitable market for loan sharks while weakening the regulated gold-loan industry?

This is not to suggest that the Government should not regulate the financial sector. Regulation is necessary. There must be safeguards to prevent excessive lending, protect financial stability and ensure responsible lending practices.

But regulation must also take into account the ground realities faced by ordinary people.

A policy can look perfectly sound on paper but have a very different impact when it reaches the poorest segment of society. If the regulated door is partially closed, the poor borrower does not necessarily stop borrowing. He or she simply looks for another door—and that door may be controlled by someone who is far less regulated and far more exploitative.

Before introducing or strengthening measures such as the 70% LTV restriction, policymakers should examine the real-world consequences for the ordinary borrower. They should assess whether the policy will genuinely protect the poor or whether it will simply transfer their business from regulated institutions to loan sharks. Good regulation must not only look at the numbers on a Balance Sheet. It must also look at the woman who has nothing left but her gold bangle when her family needs money

Fundamental question 

The Government therefore needs to ask a fundamental question: Where will the poor person go when the regulated gold-loan market can no longer meet his or her immediate financial requirement?

If the answer is that they will go to unregulated moneylenders, then we need to seriously reconsider whether the policy is achieving its intended objective.

The answer cannot simply be to tell the poor not to borrow. In many cases, they are borrowing not for luxury or consumption, but to survive an immediate financial crisis.

The Government has an important responsibility to protect consumers, but consumer protection must include protection from the consequences of being pushed into an unregulated market.

Before introducing or strengthening measures such as the 70% LTV restriction, policymakers should therefore examine the real-world consequences for the ordinary borrower. They should assess whether the policy will genuinely protect the poor or whether it will simply transfer their business from regulated institutions to loan sharks.

Good regulation must not only look at the numbers on a Balance Sheet. It must also look at the woman who has nothing left but her gold bangle when her family needs money.

That is the ground reality that must not be overlooked.

(The author, an Attorney-at-Law, is former Director General of the Securities and Exchange Commission and currently Chairman of the PMF Finance PLC)