On the list of what separates humans from our primitive ancestors, one activity usually gets neglected: lending with interest. Finance seems embedded in our DNA. We have debt records that date back more than 4,000 years. As the historian Niall Ferguson put it in his book, “The Ascent of Money: A Financial History of the World,” these ancient ledgers serve as “reminders that when human beings first began to produce written records of their activities, they did so not to write history, poetry or philosophy, but to do business.” Not surprisingly, debates about interest rates are nearly as old. Religious authorities, philosophers and even state officials have, at one point in the past, advocated a ban on interest altogether. Islam still considers interest sinful.
Questioning interest, however, is as much an ethical debate as a financial one. Does a person with more resources have an obligation to help – free of charge – a person with fewer resources for that poorer person’s benefit? For the non-Sharia compliant, the answer humanity has settled on seems to be: the person with more deserves some kind of compensation for his or her assistance, with some limitation. After all, loan recipients use what they borrow to better their own lives (either by increasing their own wealth with the loan or acquiring a possession they did not have the means to buy on their own), so why shouldn’t the lender benefit too?
As noted, however, humanity seems to have generally agreed that lenders have an obligation to limit how much they benefit from the arrangement. Many jurisdictions today ban excessively high interest, commonly referred to as usury. Lebanon has no such ban (nor do its legal codes put a limit on what interest rates lenders can charge), but Banque du Liban (BDL), Lebanon’s central bank, has devised rules to keep consumers from being buried in debt by placing limits on how much of their monthly household income can be spent repaying a lender. In the end, the effect is arguably the same.
A premium for the poor
The exact rate of interest charged on a loan does not seem to be what distinguishes an ethical lender from an unethical one. Taking advantage of the vulnerable or financially illiterate and misleading people are the real distinguishing marks of an unethical lender. For example, microfinance is currently the darling of the development community. Microfinance institutions (MFIs) lend small amounts to poor borrowers who typically invest the funds into some modest business venture. The idea is to help the poor create more wealth for themselves. Microloans come in ticket sizes far smaller than most commercial banks would ever consider (hundreds or a few thousands of dollars) and thus they come at a premium. Though the rates are higher than a bank would charge, microfinance is considered by most an ethical practice.
More important than specific rates, therefore, is just how well a borrower understands what he or she is getting into. The Great Recession might never have happened if duping poor people into buying homes they could not afford had not become such a rampant practice in the United States.
One of the biggest risks MFIs face, according to the three Executive interviewed for this report, is over-indebtedness. If MFIs do not have effective tools to communicate or a centralized list of clients and their outstanding debts, borrowers could take out several loans from different institutions, eventually finding themselves with more debt than they can afford. MFIs are hoping a new association, officially launched in mid-2015, can help mitigate this risk (known as cross lending).
Protecting borrowers from themselves
Poor decision-making on the borrower’s behalf – rather than unethical lender behavior – is not only a risk faced by micro-borrowers. People using otherwise legal services like payday loans or car title loans often get in over their heads, and governments in the UK and the US have legislated protections for people who use these services, such as legislation regarding debt restructuring and personal bankruptcy. One of the prime tools these governments are using as a protective measure is more information. The thinking goes that if a borrower fully understands the risk of certain types of loans, he or she will seek funds elsewhere. Lebanon’s central bank has also recently demanded lenders provide potential clients clear and easy-to-understand information as a consumer protection measure. For a lender-borrower relationship to be both ethical and mutually beneficial, both parties need to have agreed to all terms with a full understanding of what they mean. Further, if the borrower is coming at a moment of vulnerability, a lender has a moral — if not always a legal — obligation to make sure not to take advantage of the borrower. Until humanity agrees on an ethical paradigm to govern lending, this seems like the best we can hope for to ensure credit does more good than harm.