British payday lender Wonga recently announced that it is expanding its high interest lending from individuals to small companies. While this move has been criticized by consumer groups, who say it will hurt small business, they are wrong to oppose the expansion.
Sure, interest rates on these loans are high. Wonga, for instance, plans to charge small businesses interest rates between 0.3 and 2 percent a week.
No one wants to pay to borrow money. And most borrowers–consumers and businesses alike–would prefer to pay less than Wonga is charging. In fact, I’ll go out on a limb here and say most borrowers would prefer an interest rate of zero.
But lenders charge high interest rates for a reason. When investments are risky, rates need to be high to make up for the large number of loans that are not paid back. Consider two sets of ten borrowers. Everyone in the first group is so creditworthy that all borrowers will pay back their loans. To earn 5 percent by lending money to this set of borrowers, a lender need only charge 5 percent interest. But in the second group, which is much less creditworthy, only half of the borrowers will pay back what they owe. To earn 5 percent when lending money to this group, a lender needs to charge 10 percent.
If payday lenders are allowed to lend money to small businesses, some of their borrowers will no doubt have trouble paying off their loans and will fail as a result. It’s not easy for businesses to generate the cash flow necessary to service high-interest-rate loans. But denying those businesses access to these loans does not solve their problems. If they can’t get access to the capital they need to operate, many of them will fail anyway.
Read more: http://www.american.com/archive/2012/july/when-high-interest-payday-lending-pays
Sure, interest rates on these loans are high. Wonga, for instance, plans to charge small businesses interest rates between 0.3 and 2 percent a week.
No one wants to pay to borrow money. And most borrowers–consumers and businesses alike–would prefer to pay less than Wonga is charging. In fact, I’ll go out on a limb here and say most borrowers would prefer an interest rate of zero.
But lenders charge high interest rates for a reason. When investments are risky, rates need to be high to make up for the large number of loans that are not paid back. Consider two sets of ten borrowers. Everyone in the first group is so creditworthy that all borrowers will pay back their loans. To earn 5 percent by lending money to this set of borrowers, a lender need only charge 5 percent interest. But in the second group, which is much less creditworthy, only half of the borrowers will pay back what they owe. To earn 5 percent when lending money to this group, a lender needs to charge 10 percent.
Denying those businesses access to these loans does not solve their problems. If they can’t get access to the capital they need to operate, many of them will fail anyway.Many of the small businesses interested in borrowing from companies like Wonga have very high loan default rates. Unless lenders can charge high interest rates to these borrowers, they won’t extend them credit, which keeps these businesses from accessing the capital they need to operate.
If payday lenders are allowed to lend money to small businesses, some of their borrowers will no doubt have trouble paying off their loans and will fail as a result. It’s not easy for businesses to generate the cash flow necessary to service high-interest-rate loans. But denying those businesses access to these loans does not solve their problems. If they can’t get access to the capital they need to operate, many of them will fail anyway.
Read more: http://www.american.com/archive/2012/july/when-high-interest-payday-lending-pays
1 comment:
There is a very large dose of hypocrisy occuring in the "press" that payday loans receive. I supervised both a payday lender and its parent bank's checking account department. There were many times I suggested to customers to use a payday loan to avoid the massive overdraft charges being charged by the bank. The UK payday lender had a regulated, fixed charge, the bank, using the process of paying the largest check first in an overdraft situation, quite often charged OD fees far in excess of the amount overdrawn.
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