The Unintended Effects of Interest Rate Caps: Credit Reallocation to Safer Borrowers

Several states have recently capped consumer loan rates with the stated purpose of protecting borrowers. In a recent Staff Report , we study how these interventions have played out in three states. In our first post about that study , we showed that rate caps lead riskier borrowers to face rationing in the credit market. One question that naturally arises is what lenders do with the credit they used to provide to high-risk borrowers before the caps were imposed. Lenders that lend exclusively to high-risk borrowers (at rates above the cap) may decide to stop lending to high-risk borrowers in that state. Others, however, may try to change their “credit box” by lending more to somewhat safer borrowers. In this post, we will try to understand how lenders reallocate credit after usury limits are implemented.