Credit Unions Provide Good Lesson on Why Interest Rate Ceilings Are Bad Public Policy

Federal credit unions provide an excellent lesson regarding the unintended consequences associated with interest rate caps.

Currently, all federal credit unions are prohibited from increasing their loan rates beyond a current regulatory cap of 18 percent (12 U.S.C. §§1757(5)(A)(vii)).

On June 7, 2007, former NCUA Chairman JoAnn Johnson testified about the adverse impact of the interest rate cap on federal credit unions’ credit card operations.

NCUA Chairman Johnson pointed out that many federally insured credit unions may have sold or discontinued their credit card programs in recent years, because of rising variable costs and fixed interest margin potential. She noted that credit card portfolio brokers estimated that 318 credit unions have sold their credit card portfolios over the last five years. In other words, the inability to raise the interest rate in a rising interest rate environment did not allow the credit union to receive a risk-adjusted rate of return to warrant continuing this investment.

She also pointed out the interest rate ceiling limited the ability of credit unions to mitigate the higher credit risk of some borrowers through risk-based pricing. Therefore, the only way a credit union could manage such risk was to ultimately limit some credit union members’ access to credit.

While consumer advocates may think interest rate ceilings are the best idea since sliced bread, the experience of credit unions shows that price controls, such as interest rate caps, are bad public policy.