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Jerome Gessaroli: Lowering the maximum legal interest rate could backfire badly

Commentary

The 2021 Liberal election platform—and the Prime Minister’s subsequent mandate letter to Finance Minister Chrystia Freeland—included a promise to “crack down on predatory lenders by lowering the criminal rate of interest.”

Presumably, any new legislation intended to fulfill this pledge would primarily target “alternative lenders”: finance companies that typically offer payday, title, or installment lending products. These loans cater mostly to those with low credit scores, little collateral, and short-term cash needs. 

Payday loans are short-term. Lenders charge a fee of about $15 to $17 per $100 borrowed over a two-week period until the borrower’s next paycheque. These fees might seem innocuous. But calculated as an annual percentage rate (APR) of interest, these rates are very high (around 400 percent). Payday rates are exempt from the 60 percent legislated interest rate ceiling due to their low dollar value and short-term duration. 

With installment and title loans, a borrower may take out a loan between a few hundred to $20,000 or more. Both loan types have terms ranging from a few months to five years. While the interest rates on these loans (around 20 to 50 percent) are lower than for payday loans, they are still very high. Given the greater principal borrowed and longer payment terms, the cash payments can be very burdensome. 

It is easy to see why the government’s pledge to lower the maximum interest rate allowed is superficially attractive. After all, if unscrupulous Canadian businesses are gouging Canadian consumers, shouldn’t we welcome new laws that stop them from overcharging us? Some politicians and consumer advocates are calling for the 60 percent lending rate maximum to be lowered to between 20 to 30 percent

The fact is, however, even with the very high rates charged, alternative lenders fill a market need. There are few other borrowing options for individuals with low or no credit scores. 

Traditional banks and credit unions mostly limit personal lending and credit lines to borrowers with acceptable collateral and credit scores. In a federal government study of payday borrowers, only one in three surveyed said they had access to a credit card and only 10 percent had an available line of credit. Payday loan customers also point to better customer service and the ease, speed, and convenience of obtaining such a loan. 

Related, but more troublesome, are reports that some payday loan customers are not comfortable in established financial institutions. In other words, they think their business is not wanted and feel subject to discrimination. Several credit unions have introduced lending products suited to non-secured, lower credit-rated customers, but the credit supply is nowhere near the size to replace the alternative lending sector.

Alternative lenders charge high rates because the loans they make are risky. Default rates are higher than those of traditional financial institutions. Physical storefronts add to a high fixed-cost business model. Lowering the interest rate ceiling as much as a few politicians and low-income advocates have called for, would make lending to lower credit-rated individuals uneconomical. 

The same government study referenced above also reported that common reasons for needing a loan were for everyday expenses like car repairs, rent, or to avoid late payment charges on a bill. Less than one in 10 said it was to “buy something special.” 

Based on these responses, access to short-term funds is essential to respondents’ financial wellbeing. They may need a car for employment. Unpaid bills could lead to late payment charges and even lower credit scores while missing a rent payment could mean eviction. Studies also report that “credit building loans,” a type of installment loan product, can help to improve credit scores for those with a poor credit rating. Restricting or eliminating alternative lenders will reduce credit access and increase the financial consequences for those who can no longer borrow.

This does not mean government cannot take steps to regulate credit markets to stamp out abuses. Several practical measures can be taken. The first lies in the type of information lenders receive when obtaining short-term, high-cost loans. Providing clear, easy-to-read loan information, in a manner that allows borrowers to think about and compare lending costs, leads to fewer loans used. Second, given that individuals with more financial knowledge use fewer high-cost loans, improving financial literacy is also important. Lastly, restricting the number of high-cost loans over a period reduces the chance a borrower falls into a debt trap. If we can meaningfully reduce high-cost loans usage without restricting credit access, we can avoid the negative unintended consequences that frequently occur when we use blunt market suppression tools. 

It is understandable and appropriate that governments are concerned and looking to protect financially vulnerable Canadians. But lowering the maximum legal interest rate could backfire badly —and hurt those they are trying to help.

Sean Speer: Creeping politicization strengthens the need for PBO reform

Commentary

Last week the Parliamentary Budget Office released a report that analysed the federal government’s Economic and Fiscal Update from late last year. It has since generated significant policy and political attention in a way that may tell us as much about the ill-defined and creeping mandate of the PBO as it does about Ottawa’s finances. 

The PBO’s analysis, which was produced to “assist parliamentarians in their budgetary deliberations”, provides insights into the government’s economic and fiscal projections, its spending plans, and its fiscal transparency, including the current timeliness of its financial reporting. This basic information should be valuable for parliamentarians as they carry out their responsibilities for legislative oversight and parliamentary appropriations in the lead up to the forthcoming federal budget. 

But the PBO’s report drew particular attention for its commentary on the weak justification for the government’s plans for a $100 billion fiscal stimulus over the next three years. The Parliamentary Budget Officer, Yves Giroux, indicated in the report (and accompanying media interviews) that it “appears to me that the rationale for the additional spending initially set aside as ‘stimulus’ no longer exists.” These comments set off a series of news stories about how the PBO had essentially rebuked the government’s profligate spending plans. The Prime Minister was even asked to respond in a subsequent news conference. 

I happen to agree with the PBO’s assessment. It was odd for the Trudeau government to commit to a specific stimulus plan in December 2020 before it had any idea on the timing and scope of the post-pandemic recovery. It’s now clear based on the government’s own economic projections that the size of its stimulus plan and its three-year duration are wholly unjustified and may even have negative inflationary effects.

Yet even though I share the PBO’s critique of Ottawa’s stimulus spending, I also think the PBO and its staff shouldn’t be offering its editorial opinions on government policy or accepting media interviews or generally injecting itself into politics. This recent case is merely another example of a longstanding issue of the PBO’s mission creep from a neutral research capacity on behalf of parliamentarians to a highly publicized and oppositional actor in federal politics. 

I should emphasize here that this isn’t a comment about Yves Giroux who I have had the privilege to work with in Ottawa. He’s smart and decent and well-qualified for the role. Instead it reflects a flaw in how the PBO’s role has been conceptualized since its creation in 2006 and the institutional incentives that have since exacerbated this initial mischaracterization.

It’s worth remembering that the PBO started as a Conservative Party policy promise in the 2006 election campaign. It was characterized at the time as part of a sweeping set of reforms to improve financial transparency in response to the Sponsorship Scandal.  

The campaign promise was subsequently effectuated in the omnibus legislation, the Federal Accountability Act, which created a number of new offices (including the Commissioner of Lobbying, Public Sector Integrity Commissioner, and the Conflict of Interest and Ethics Commissioner) and obligations (including post-employment restrictions and new party donation rules) to strengthen accountability and transparency within the federal government. 

Although the PBO was framed as part of this broader agenda, it was never quite a perfect fit. The real case for the new office was less about corruption and more about enhancing capacity for parliamentarians to carry out their roles including voting on budgetary estimates, advancing Private Member’s business, and generally fulfilling their responsibility for legislative oversight of the government. 

MPs have small office budgets and minimal capacity to understand and track appropriations bills or to be able to develop their own policy proposals independent of the government. This creates a powerful asymmetry that has contributed to the centralization of our political system and a smothering form of caucus discipline. The PBO should in theory empower parliamentarians to better scrutinize government legislation on one hand and enable greater policy entrepreneurship within parliament on the other hand. 

Yet its inclusion in the post-sponsorship response was in hindsight an impediment to this role. It necessarily led to an emphasis on “promoting greater budget transparency and accountability” and an underlying assumption that the government’s fiscal projections can’t be trusted and need to be challenged. This shifted the PBO’s focus away from acting as a neutral research capacity for MPs and contributed an adversarial ethos from its early beginnings. 

Its founding legislation did stipulate that the office should undertake economic and fiscal research on behalf of parliamentary committees and produce cost estimates for parliamentarians. But these activities were subordinated to “provid[ing] independent analysis to the Senate and to the House of Commons about the state of the nation’s finances, the estimates of the government and trends in the national economy.” 

Since 2017, the PBO has also had a role in helping federal political parties cost out some of their platform commitments. (As I’ve previously written for The Hub, I’m generally supportive of this new function, though the imperfect experience of the last federal election suggests that it’s still a work in progress.) 

The key point though is that the emphasis on the PBO’s role in producing analysis on “trends in the national economy” has granted the office tremendous scope to proactively weigh in on a range of policy issues. It has used this vague mandate to essentially inject itself into political debates by contributing editorial commentary on what amounts to a set of normative issues. 

Is the deficit too big? Are spending increases justified? Should Ottawa spend on X versus Y? These are fundamental questions for which there’s no shortage of opinion in Canadian life. It’s far from clear that there’s a market gap that requires filling by a taxpayer-funded institution. That successive Parliamentary Budget Officers have frequently sat for television and radio interviews is a sign that the office has come to see their role as extending beyond parliament and their audience as more than just parliamentarians. 

There was perceived political upside to elevate the PBO and its work for the political parties

Legislative amendments in 2017 to bring greater clarity to the PBO’s mandate (which the office opposed), including a requirement that it produce an “annual work plan” which is reviewed and tabled by the Speakers of the House of Commons and the Senate, essentially left its broad and general mandate in place. 

These recent reforms have even arguably narrowed the scope for the PBO to support individual parliamentarians by limiting this work to when parliament is sitting. The net effect is to inadvertently double down on its adversarial role of second-guessing the government’s economic and fiscal projections rather than primarily serving as an external and independent policy development capacity for individual MPs.

Powerful incentives have also pushed in this direction. The parliamentary press gallery and opposition parties responded positively to the PBO’s early oppositionalism which only served to reinforce it. It’s notable, for instance, that the 2015 Liberal Party and NDP campaign platforms committed to strengthening the PBO’s independence in light of its conflicts with the previous Conservative government. There was perceived political upside to elevate the PBO and its work for the political parties and this, in turn, raised the profile of the PBO and encouraged its unique form of communications and media engagement. It was a virtuous (or perhaps vicious) cycle that essentially validated the PBO’s adversarial and public-facing model.  

The challenge, of course, is that the PBO’s highly publicized role creates a set of political economy conditions in which no government is prepared to assume the political risk of reforming its legislative mandate. There’s no upside to challenging one of the government’s highest-profile and well-researched critics. The risk though is that we end up with stasis in which everyone essentially agrees that the status quo is flawed but no one is prepared to say so. As the Parliamentary Budget Officer continues to be a high-profile political actor, the inevitable outcome is his or her oversized profile will make it even more challenging for parliament to enact sensible reforms to the office’s mandate, focus, and activities. 

There’s a strong case for a PBO that conceptualizes its role more narrowly as helping parliamentarians in evaluating the economic and fiscal costs of new and pending government legislation. There also ought to be a role in supporting individual MPs in their own policy work as well as providing analysis and cost estimates for party platform development. These are core functions that solve for a “market failure.” 

Such an office could be a key part of a broader agenda to rebalance the relative power of MPs and the government. The PBO can in short be a key institution in the renewal of Canada’s parliamentary democracy rather than another voice in the country’s acrimonious political debate. 

But the only way for such institutional reform to happen is if the different political parties represented in the House of Commons come together on a shared set of legislative changes to clarify and circumscribe the PBO’s role. A multi-partisan consensus is a crucial ingredient. Any meaningful reform is otherwise bound to devolve into partisan one-upmanship. The consequence will be that the PBO continues to operate as a primarily oppositional voice in federal politics and the policy capacity of parliamentarians is harmed as a result. 

Just because one agrees with the PBO’s criticism of the government doesn’t mean that it ought to be weighing into political issues. Both ideas can be right. So is the case for reform.