One week ago, the Nobel Prize committee honored the idea of microcredit with the 2006 Nobel Peace Prize to Muhammad Yunus and his Grameen Bank. Four days later, the United States government moved to make our own version of microcredit, the payday loan, unavailable to military personnel:

President Bush signed the 2007 National Defense Authorization Act Tuesday. The Act includes an interest rate cap of 36% for payday loans made to military personnel.

The rate cap was authored by Senators Jim Talent (R-MO) and Bill Nelson (D-FL). In addition to the 36% cap on annual interest rates, the amendment prohibits use of a personal check or other method to access the borrower’s bank account, or the title to their vehicle as collateral for a small loan.

Note that the “interest rate” capped by the Act includes all service or transaction fees. If the transaction fee to borrow $100 for a week is $10 (which is cheaper than bouncing a check or missing a credit card payment), that is computed as $520 per year, or as a “520%” addition to the “annual interest rate”.

Like payday loan companies, the Grameen Bank specializes in small loans, though typically for longer periods (six months or so, rather than one week). Here’s what its website says about high interest rates charged by “microfinance instutions”:

I’ve heard that MFIs charge a high rate of interest for the loans. Is that so?

Like other financial institutions, microfinance institutions (MFIs) charge interest for the loans they make to their clients. The interest covers the high cost of making very small loans and personally servicing each client every week. It also covers the cost of managing the “center meetings”; the peer support group process; and providing information on social services, personal development, health and other critical information that helps clients improve their lives and the future of their families. Their rates are also affected by the rates MFIs themselves pay for borrowing the funds that they in turn lend to their clients. MFI interest rates can range from 15 to 35 percent, depending on the conditions in each MFI’s service area. Without microfinance programs, the only alternative for very poor people is often borrowing from local “money lenders,” who regularly charge between 120 and 300 percent.

Sounds reasonable to me, but evidently not to my US Senator.

Is 36% too low a ceiling to allow cost-covering payday loans? Yes. (Excercise to the reader: figure out how low the transaction cost on a $100 one week loan would have to be to fit under the 36% annual cap.) In response to the legislation, Advance America, the “largest provider of payday cash advance services with approximately 2,700 centers in 36 states” has announced it will stop providing payday loans to military personnel. Let’s hope that those personnel have other alternatives than our own version of local money lenders, also known as “loan sharks”. Or as Advance America’s CEO delicately called them, “more expensive and/or unregulated forms of credit."

With columnists calling for extending the 36% cap to all payday loan customers (effectively the outlawing of payday loans), the payday loan industry might want to consider hiring Muhammad Yunus as a consultant and spokesman.