Back to Basics

This post was originally published by Community Credit Lab, which is now part of Common Future.

How you answer these questions likely depends a lot on your demographics – specifically, how much you earn, your race, your address, your income, your parents’ resources, etc. If we’re building towards an equitable society under Creative Reaction Lab’s Equitable Design Principles, people will need to have access to what they need to thrive based on their specific circumstances. With respect to credit, wouldn’t that mean that people with fewer resources were able to access credit at rates that were lower (not higher) than people with more resources? How does charging people with fewer resources more to achieve their economic goals build towards an equitable society? Especially, when that interest too often accrues to financial intermediaries (owned and managed by wealthier demographics) and institutional or accredited investors (wealth managers and owners).

The reason I mention 36% as the starting point for these thoughts is that it is the rate that was just passed into law by the Illinois Governor as the cap on consumer lending interest in order to curb “predatory lending” practices that extract enormous amounts of capital from financially underserved communities. While predatory (a.k.a. payday) lending can often be at rates as high as 300%, the “decided appropriate” current national standard cap of 36% interest brings up questions that we think about a lot at Community Credit Lab: what is the line between predatory lending and affordable lending? Who should decide the rates that are supportive or harmful?

Given the nature and future of lending, many tools and technologies are being incorporated to recoup principal, interest, and fees. These tools include revenue based financing (where a portion of revenue is paid to principal and interest), up-front fee based lending (which may qualify as acceptable under Islamic Finance), and convertible debt (where debt converts to ownership at a given trigger point). Like any financial mechanism, each of these tools can be applied with varying returns for investors and varying degrees of extraction from borrowers. Layer on fintech applications and access to credit increases, but affordable credit decreases often in inverse correlation to access. “Affordable” is deliberately misused as a term to market products that still extract in a grey area between affordability and predatory using traditional financial risk/return analysis. What does affordable credit mean to you? What rate would you go to a bank or fintech and hope to get a loan at?

In the context of fintech and even many community microfinance lenders, a rate of 36% interest may not only be deemed acceptable, but deemed affordable since the benchmark for these rates is the payday lender that would otherwise be an alternative option. But what if the benchmark was the best possible rate available to anyone on the market instead? What if it was the rate that the people managing financial intermediaries could access credit at?

Our assumption is that, for most people signing off on issuing loans at 36%, this rate would not be considered affordable for themselves. So how can it be equitable? What rate should be?

If you’ve been following our work at CCL closely, you’re aware of 3 things:

1. We benchmark against the IRS’ Applicable Federal Rates since these are the rates that wealth owners transfer intergenerational wealth to their kin (i.e. when wealthy people lend money to their kids, they lend at this rate to transfer their wealth).
2. All consumer lending programs that we facilitate are at 0% interest without fees.
3. All commercial lending programs that we facilitate will be at prime interest or less without fees (not only that, borrowers don’t pay our costs to achieve their goals – any applicable commercial loan interest goes to our relevant Lending Partners only).

At CCL, we know that costs matter – whether it’s the cost of capital from investors, the costs of running lending programs, or the cost of capital to borrowers. We start with the cost of capital to the people our partnerships support and work backwards to build our operational cost model (funded by philanthropic contributions, service revenues, and investment management fees) and attract affordable capital from investors, not the other way around.

Too often, investment strategies begin with preset parameters and definitions from the top down. Whether it’s determining that 36% is the threshold for what should be deemed predatory and overly extractive or it’s an investment advisor negotiating to push up a rate of return for a client, it’s important to remember that these parameters trickle down into how capital is allocated to borrowers and see borrowers as people in our community first. Let’s get back to basics and start by asking: how can we best center people and their goals first and foremost?