Tough restrictions could deter firms from giving short-term loans to poor.

One of the final acts of the last parliament was passing the Credit Contracts and Financial Services Law Reform Bill, to reign in the pernicious effects of loan sharks. This is another example of the arrogance of government bureaucrats who believe poor people are stupid and need protection.

It is now illegal for lenders to make a profit from default fees and permissible for defaulters to demand relief from their lenders should they fall into undue hardship.

More onerous are the responsibility principles now in law. Lenders must take care to assist clients and risk their loans being unenforceable if they are found to have breached these vaguely defined principles.

Other burdens include ongoing disclosure requirements, restrictions on repossessing goods and adherence to a yet-to-be-drafted Code for Responsible Lending. These obligations impose costs to servicing the market for short-term loans and will deter some firms from entering the market.

Payday loans originated in the US as competition to pawn shops. In several states they were subject to regulation, oversight and registration. In 2007, the Federal Reserve of New York looked into the issue. It had the advantage of being able to compare states with low oversight to those with strict regulation. Two interesting findings came out.

First: households with uncertain income in states with unlimited payday loans were less likely to default. Second: these states had more providers and therefore lower costs to the debtors.

Regulating payday lenders restricts their number, which increases the level of interest those remaining can charge. To quote the Federal Reserve: “Despite their alleged naivete, payday borrowers appear sophisticated enough to shop for lower prices. The problem of high prices may reflect too few payday lenders rather than too many.”

One lender in this market, the delightfully named Save My Bacon, made the point that many clients were willing to pay a premium for the improved service from smaller providers. These borrowers are unable to get credit from a bank or prefer a more expensive but better focused service provider.

The effect of this legislation will be to deter financial service firms from providing short-term loans to the poor, or worse, push those desperate for credit into the hands of lenders who operate outside the constraints of contract law to enforce their debts.