Regulatory design is hard.


Designing good regulation is difficult. When the Queensland government was concerned about payday lending, it decided to cap the annual interest rate that such lenders could offer at 48%. But as a story on this morning’s ABC radio illustrates, capping interest rates is easier said than done.

Apparently a Queensland payday lender was getting around the interest rate cap by a series of contracts that supposedly related to diamond purchases and sales. To put it simply, the borrower agrees to buy $2000 worth of diamonds from the lender (presumably with the payment due in the future) and simultaneously agrees to sell those same diamonds back to the lender for $1000 (with immediate payment). The borrower walks away with $1000 but has a $2000 debt, payable at a future date.  As this is a diamond transaction, not a financial transaction, the payday lender was hoping to avoid the relevant legislation. The matter is currently before the courts.

The lesson here is a common one. Businesses have strong incentives to get around regulations that limit their profit. Well-meaning regulation that is not fully thought through will, at best, be benign and, at worst, will harm those people it is meant to protect.

3 Responses to "Regulatory design is hard."
  1. Regulations not thought out?  Well it’s the law of unintended consequences I suppose, but how exactly can they regulate around things like this?  How stupid would they have looked if the act had banned high interest on diamond swaps?  And who would have thought of it?

    Sometimes the law can only respond to events, if it doesn’t want to pass a law too broad to stop normal activity.  It’s not as if the law has even failed at this point.

  2. Stupid regulation anyway.  Man wants $1,000 to deal with some short term financial difficulties, will repay on pay day.  Pay day is, say, no more than 14 days hence.  Payday Lender lends man the $1,000.  What’s the most that Lender can charge Man for the use of the thousand dollars for a fortnight?  Well, in Queensland, about $18.41.  So, all payday lenders are driven out of the Queensland market, and Queensland’s consumers are left without a convenient credit facility to smooth their short term consumption in the face of income shocks.
    I’m barracking for the diamond shark.

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