By Klaus Issler; part three of a series. Reprinted from the Oikonomia Network.
When friends learned I was studying lending in the Old Testament, some asked: What about “payday loans”? Let’s see how the Old Testament’s teaching about loan ethics applies to this controversial practice.
As we have seen, one component of Old Testament generosity for the working poor is loans to support subsistence expenses; in such loans, interest should not be charged. Another important but less recognized category of assistance is loans for productive business purposes, on which it is appropriate to change interest.
For many years, microfinance institutions have been making Small-Dollar Loans (SDLs), with interest, to poor entrepreneurs around the globe. The business activities supported by these loans have contributed to the significant reduction of those living in extreme global poverty. This builds on the Old Testament’s ethic of loans that we looked at in a previous series. But what about SDLs for low-income workers in a highly developed economy like the United States?
One thing I hadn’t thought much about before I began researching this issue was how common it is for people like me to take access to credit for granted. For example, as stewards of God’s material gifts, we may regularly use a credit card as a common feature of everyday life, without appreciating the fact that we have access to this beneficial and convenient resource we have at our disposal. But this simple means of credit is not available to a large number of people around the world, including a good number in the United States. In the modern economy, businesses and individuals need regular access to affordable credit that does not entrap them into deepening amounts of debt.
In this article, we explore the ethical questions raised for alternate credit providers who supply financial services to lower-income workers. This is an economically complex sector, one that is usually hidden from most of us. Predatory lending that traps people in debt for the purpose of extracting money from their distress is wrong. At the same time, we want responsible credit services to be available to people at low income levels. Some organizations that make SDLs to low-income workers are committed to helping those workers break out of the cycle of poverty and debt.
Challenges Facing Alternative Financial Service Providers
Although low-income workers in the U.S. and around the world need access to SDLs for various reasons, securing funds through traditional banking is often not an available option. Barriers include factors such as more stringent borrowing requirements (to mitigate the risk of lending to people with fewer visible means to repay) and the higher relative cost for servicing short-term SDLs in proportion to the loan amount (i.e. the cost of processing each loan is much higher as a percentage of the total loan). Racism has also played an important role in denying people access to credit.
Non-standard banking centers provide convenient access for financial services unavailable elsewhere to low-income poor who are either “unbanked” or “under-banked” in their communities. The ethics of these services is where the tough questions arise.
It’s important not to jump to conclusions too quickly from seeing big numbers that seem outrageous. New York State sets a maximum annual interest rate of 48% for pawnshops. This sounds like an unjustifiably high rate – and it would be, if it were the rate on a multi-year loan. However, if the loan is paid back in a few months, the rate actually paid will be much lower than 48%. The annual rate is calculated by determining what the borrower would pay if the loan were held for a year; if the loan is not held for a year, less will be paid.
Jay Richards offers this example, using 2013 dollar values:
It is like comparing the price per mile on taxi service in Manhattan with the price per mile on a round-trip flight between New York and Los Angeles. The flight costs $70 per 1,000 miles. The taxi will run you over $2,000 [per 1,000 miles] for the same distance….This way of measuring the consumer’s cost makes the cab ride look like a huge rip-off, when it could very well be your best way to get from Battery Park to Eighty-Fifth Street for a job interview. (Infiltrated, p. 211)
Richards points out that a $100 loan for two weeks at $15 interest works out to an annual rate of 391%. Yet $15 would not cover the processing time plus overhead (rent, utilities, insurance, etc.) required to make the loan. And that’s before factoring in risk of default.
Credit Builders Alliance notes that financial institutions have to face tough questions about their business models. In a 2012 survey of U.S. nonprofit organizations serving low-income people, leaders voiced their unease about the extra operating expenses for both processing SDLs and the risk of default. Of the 44 that had either begun offering SDLs or were seriously considering doing this, 83% “are concerned that the interest rates they charge or plan to charge will not be enough to cover the cost of the loan product” and 80% noted that these rates “will not be enough to cover the risk of loan losses” (“Small Dollar Consumer Loans: Nonprofit Lenders Making a Difference,” Credit Builders Alliance, p. 8).
Yet, after all these concerns are on the table, the potential for predation remains. Who can doubt that many institutions “serving” low-income customers are not authentically serving them, but taking advantage of their distress? There is no reason to think that institutions serving the poor would be more scrupulous than others, given that their clients have less power to hold them to account.
Big rate numbers don’t prove, by themselves, that predation is happening in any particular case. But that can’t be an excuse for complacency. The best way to protect people from predation is to create superior options.
Are payday lenders, with the potential for predatory lending, the only option for the poor? Depending on which borrowing requirements can be met, low-income borrowers may have access to SDLs from a range of organizations that seek to help borrowers to break out of the cycle of poverty and debt. And the church can mobilize to create more such options.
I name two specific organizations, not necessarily to endorse them but to illustrate that such groups exist. Both organizations are certified as “Community Development Financial Institutions” by the U.S. Treasury Dept., and offer starter loans of $300 minimum.
The Capital Good Fund in Providence, R.I., is a nonprofit established in 2008. Founder and CEO Andy Posner says its mission is “to provide equitable financial services that create pathways out of poverty.” It has served almost 2,800 clients to date, and offers a year-long financial coaching program for an additional fee. The founder indicated that fees and interest only cover about 25% of their budget; grants and donations must be secured to meet remaining operating costs, although now they are involved in a five-year campaign seeking more investors with the goal to become fully funded by interest payments.
The mission of Oportun (formerly Progeso Financiero), a for-profit lender established in 2006, is “to provide affordable loans to help people with little or no credit history to establish credit and build better future,” and has served over one million clients to date. Borrowers can supply an ID either from the U.S. or from another country.
Yet there are many who cannot use such providers because they do not have the appropriate legal documentation. We are familiar with this dilemma here in the U.S. when it comes to workers who have entered the country unlawfully. But the problem is much bigger on a global scale.
In most of the majority world, the working poor are typically forced live and work in the “extra-legal sector” in their respective countries, according to Peruvian economist Hernando de Soto. When villagers migrate to cities, not only are public services overwhelmed, outmoded laws become too much red tape for these nationals either to gain business licenses or to buy land or rent housing. In his landmark book The Mystery of Capital, he writes: “As we have seen, the poor in developing and former communist countries constitute two-thirds of the world population – and they have no alternative but to live outside the law” (p. 74).
In such cases, securing SDLs may only be possible through pawnshops, payday lenders and the equivalent. They may not require legal documents or credit-history checks, but only collateral in the form of a pawn or the worker’s next paycheck. Too often, payday loans can entrap borrowers into a cycle of recurring loans, increasing and not diminishing the debt load.
A number of reputable microfinance institutions in the majority world offer SDLs with no ID check, no credit check, and no collateral. They employ a “social” pledge in the form of accountability groups. “The microfinance movement has developed relatively low-cost ways of addressing the three C’s [character, capacity, and collateral], often using group-based incentives based on joint liability for loan repayment” (Brian Fikkert and Russell Mask, From Dependence to Dignity, p. 205). By making SDLs available, these organizations offer a means for poor entrepreneurs to move out of poverty. When the recipients are believers, these loans indirectly build up local church communities as well.
Action Points for Christian Leaders to Ponder
In light of this very active but hidden sector of alternative financial services, Christian leaders in the U.S and overseas may consider these possible strategies when considering the situation of low-income workers trying to meet their own capital needs.
Locally, we could can band together to vet local alternative-lending organizations in our communities whose mission is to help the low-income working poor. Churches and parachurch organizations could develop a recommendation list or seal of approval. A regional website could announce a vetted list of local alternate financial providers. The few credit unions that offer SDLs can also be included. More information and suggested guidelines for vetting are offered by the National Consumer Law Center in a 63-page booklet: “Stopping the PayDay Loan Trap.”
Local churches can also provide personal financial coaching to guide people how to get out of debt and to begin a realistic savings plan. Widely used and helpful providers include the Chalmers Center, Thrivent and Dave Ramsey. Word of mouth in local church communities may be the most reliable way to get low-income workers connected to these opportunities.
Globally, we could consider how our churches or organizations could participate in the economic outreach taking place throughout the world by collaborating with microfinance institutions. Fikkert and Mask propose a “Partnership Model” in which the microfinance institution offers the financial services, which is what they do well, while churches provides the non-financial services these loan recipients need, which is what they do well. This includes the gospel message, discipleship, Bible study and counseling; it could also include technical services and medical care. Individuals can invest their own funds to support microfinance, yet microfinance and recommended local alternate financial organizations are the ones doing the actual lending, since they have the experience and efficient systems. Fikkert and Mask strongly warn churches not to take on the financial services, but to partner and provide the non-financial services in which they have competency.
Review: Old Testament Teaching and Application on Lending and Interest
Quickly reviewing the key insights of the Old Testament for lending ethics:
1. Two lending categories are identified in the Old Testament: a) interest-free lending for the working poor for subsistence, and b) productive loans at interest for business purposes.
2. Interest-free subsistence lending is one component of Old Testament generosity for the working poor who have reasonable potential to repay, because loans (rather than one-way giving) can affirm the dignity of the recipient and avoid the potential for long-term dependency.
3. The interest-free subsistence loans anticipated in the Old Testament correspond best in today’s context to informal, personal interest-free loans within one’s own network of family and friends, rather than organizational loans. Apart from access to such an informal network, seeking some form of charity may offer the best means of temporary relief.
4. Currently, productive loans with affordable interest from microfinance institutions greatly benefit many working poor around the world to help them rise out of poverty through their business activities.
5. Wherever humans are engaged in financial transactions, there is a potential for abuse.
“Good will come to those who are generous and lend freely, who conduct their affairs with justice.” (Ps 112:5)
“Do not turn away from the one who wants to borrow from you.” (Matt 5:42b)
For further details on the biblical study of this topic, see: Klaus Issler, “Lending and Interest in the OT: Examining Three Interpretations to Explain the Deuteronomy 23:19-20 Distinction in Light of the Historical Usury Debate,” Journal of the Evangelical Theological Society, vol. 59, 2016, p. 761-789.