High interest rates still better than no access

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Charge 80% per year on a loan in the U.S. and you're called a usurer. Charge 80% per year on a loan in Latin America or Africa and you can be a poverty-alleviation charity.

Dean Karlan, president of Innovations for Poverty Action, and Jonathan Zinman from Dartmouth College set out to find out if consumers can be made better off even when borrowing at "excessive" rates from regulated financial institutions:

[We] tested this proposition. We worked with a successful finance company in South Africa to randomly choose some just-below-the-normal-approval-bar applicants to receive a four-month installment loan. The lender charged its normal rate: 200% APR. The remaining, just-below-the-normal-approval-bar applicants (the "control group") were rejected in line with the lender's normal credit policy.

We then tracked both groups over the next six to 27 months […] Applicants who were randomly approved for a loan had higher incomes, less hunger, better credit scores and more positive outlooks than their control group counterparts -- even after paying the high interest rate. Though they had higher than normal default rates, the borderline loans were also profitable for the lender.

The new borrowers did report higher stress and depression levels than the control group. But overall, the borderline loans objectively did more good than harm. Our findings are striking because governments that restrict credit access do so on the premise that consumers make themselves worse off by borrowing at high rates.

Full text in the Wall Street Journal editorial [subscription required].

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