California Legislature Passes Rate Cap Bill

Last Friday, the California State Senate passed the Fair Access to Credit Act, which would cap interest rates at 36 percent plus the Federal Funds Rate (over the past decade, this has been between 0 to 2.5 percent) on loans between $2,500 to $10,000. The bill would also prohibit prepayment penalties and would set a minimum loan term of 12 months and a maximum term of five years. 

The legislation has received substantial criticism since it was first introduced. For example, Dan Gwaltney, president emeritus of the California Financial Service Providers (an industry coalition), argues that lenders would not be able to issue short-term loans under a 36 percent APR cap. The rate would simply cut off credit access for those who need it the most.

In addition, he attacked the argument that small-dollar loans are predatory by nature. “The vast majority of consumers who access credit in this marketplace are using loans responsibly and they’re using them because they have a shortfall in their financial situation, and they use them as bridge loans to get them through that,” said Gwaltney. “If they were negatively being hurt constantly, they would not access this product.”

Senior staff at both the California Hispanic Chambers of Commerce and the California-Hawaii State Conference of the National Association for the Advancement of Colored People (NAACP) voiced their opposition as well, arguing that the bill would restrict access to credit for those who need it the most.

The results of a recent study by the World Bank appear to confirm these concerns. The authors found that interest rate caps can reduce the cost of credit and limit predatory practices by certain lenders, but they often have adverse and unintended side effects, including “increases in non-interest fees and commissions, reduced price  transparency, lower credit supply and loan approval rates for small and risky borrowers, lower number of institutions and reduced branch density, as well as adverse impacts on bank profitability.”

Despite the opposition and criticism, the California legislature sent the bill to the governor’s desk on Friday. California Governor Gavin Newsom is expected to sign that bill into law.