A recently-released Federal Reserve Board article, “The Cost Structure of Consumer Finance Companies and Its Implications for Interest Rates: Evidence from the Federal Reserve Board’s 2015 Survey of Finance Companies,” provides strong support for industry’s position that interest rate caps can be harmful to consumers by limiting the availability of small dollar loans.

The article begins with a discussion of a 1972 report issued by the National Commission on Consumer Finance (NCCF). The NCCF was established by the Consumer Credit Protection Act of 1968) to study consumer credit markets and recommend improvements in consumer credit regulations.  After analyzing the cost factors involved in determining interest rates and their implications for interest rate ceilings, the NCCF report found that break-even interest rates for loans made by consumer finance companies were quite high at small loan amounts because of the impact of fixed operating costs.  The NCCF report concluded that “[w]hen rate ceilings are below the levels indicated [by the estimated break-even rates], staff studies show that [consumer] finance companies can stay in business only by greater loan sizes, limiting their risk acceptance to more affluent consumers, and maintaining large volume offices.”  The Fed article observes that although consumer credit markets have changed considerably since the NCCF report was published, the Fed’s findings suggest that “the NCCF’s conclusions are still valid today.”

The Fed article also focused on consumer finance companies, commenting that their heavy concentration on personal cash loans makes such companies particularly useful for studying the costs of consumer lending.  Using data from the Fed’s 2015 Survey of Finance Companies, the article found that break-even APRs were quite high for small loan amounts but declined rapidly as the loan amount increased.  A $594 loan required a 103.54 APR, a $1,187 loan required a 60.62 APR, and a loan amount of $2,530 was necessary to break even at a 36 APR.

Based on an analysis of data from the 2015 Survey, the article reaches the following conclusions:

• Despite the many changes in consumer credit markets, a large share of costs of small personal loans at consumer finance companies remain fixed.  While automation may displace some activities previously performed by employees, technology does not eliminate the need to have employees available to originate loans, process payments, and collect delinquent accounts.  In addition, the use of computers and communication systems and personnel to operate them also results in fixed costs.
• Small loans are relatively more costly than larger loans.  With substantial fixed costs, high interest rates are necessary to provide sufficient revenue to cover the costs of providing small loans.
• If small loan revenue is constrained by rate ceilings, only large loans will be provided.  Consumers who need a small loan or only qualify for a small loan would not be served.

The Fed article serves as further evidence for why efforts to enact a national usury cap are misguided.