Interest Rate Policy

This Framing Note explores the dilemma that policymakers face regarding the interest rate control regime applied to small or microloans.

The past three decades have witnessed the liberalization of interest rate regimes to legitimize and encourage small-scale lending. Charging high interest rates on small loans however, remains highly sensitive, and often, politically controversial. The paper states that:

• Empirical evidence on the welfare impact of small loans is limited and mixed;
• Policy implications of these findings for the interest rate control regime are complex;
• Policymakers face a dilemma which involves tradeoffs between greater access to financial services and risk of consumer abuse;
• Theoretical arguments for interest rate liberalization are strong, but changes in interest rate regime alone can have limited or even perverse influences on desired outcomes;
• Hard evidence of the effect of interest rate regimes is limited although it seems that changes in regime can have a strong incentive effect on private suppliers.

The note suggests that other tools such as disclosure requirements, competition policy or effective consumer protection may be better approaches to manage policymakers’ dilemma.