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July 3,1 981

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Over The Limit
Usury laws, an ancient device for setting legal
limits on loan interest charges, have recently
reduced consumer-credit availability in states
with low statutory ceilings. Their effect thus
has resembled the impact of interest-rate
ceilings on the supply of passbook-savings
deposits. Below-market interest-rate ceilings
on deposits-deposits being loans made by
consumers to depository institutions-have
induced consumers to shift their funds from
low-yield passbook-savings accounts into
financial assetspaying a market rate of return.
(The recent boom in money-market mutual
funds exemplifies this trend.) Similarly, in periods of high interest rates, low fixed-rate usury
ceilings have induced financial institutions to
restrict their consumer lending in favor of
other types of assetsyielding a market return.
Consumer creditthus has contracted as financial institutions in usury-law states have
shifted their loanable funds to other markets.
The Depository Institutions Deregulation and
Monetary Control Act of 1980 (MCA)
represented an attempt to end low fixed-rate
ceilings both on loans made by lenders to
consumers (usury statutes) and on loans
made by consumers to banks and thrifts
(deposit ceilings). The provisions of the Act
should reduce the likelihood, and severity, of
the periodic consumer-credit crunches and
deposit shortages caused by ceilings in the
past. Following the trend started by the
regulatory agencies' authorization of
market-yielding money-market certificates in
1978, the Act provided for a phase-out of
deposit rate ceilings over a six-year period.
(Last week, the Depository Institutions
Deregulation Committee set a definite
timetable for the phase-out.) The Act also
preempted usury ceilings on mortgage and
consumer loans, as well as on some small
business and agricultural loans.

Why ceilings?
Usury, in its archaic form, referred to the act
of charging interest for the use of money.

Today, the payment of interest is taken for
granted throughout most of the commercial
world-except for countries like Saudi
Arabia, where religious strictures prevai I
against the practice. But even in the
present-day United States, debates continue
about the charging of "usurious" or
"exorbitant" interest.
Almost all American states have usury ceilings of some type. These laws set maximum
interest rates that lenders may charge on
specific types of loans. The statutes typically
"attempt to limit interest rates, fees, discount
points, or other charges on loans to Individuals or small businesses. The ceilings may
vary according to the type of lendercommercial bank, thrift institution, finance
company, mortgage company, or individual
-or they may apply to all lenders. Other
factors-purpose of the loan, type of borrower, and size of loan -may also determine
ceilings. In modern times, however, most
stateshave Iimited the use of usury statutes to
mortgages and consumer loans.
Some states have set consumer-loan ceilings
at a fixed rate. The state of Washington, for
example, until quite recent months imposed
a 12-percent ceiling rate. Some ceilings may
be tied to a market-determined interest rate
such as the Treasury bill rate-Washington'S
new ceiling is four percentage points above
the equivalent coupon yield on 26-week
Treasury bills. Orceilings may be based on an
administered rate, as in Alaska, where the
ceiling is set at five percentage points above
the discount rate charged by the Federal
Reserve Bank of San Francisco.
Legislatures typically have enacted usury
ceilings to protect small borrowers, in an
attempt to guarantee that available credit
would be priced at a "reasonable rate."
Supporters have argued that a legal
maximum rate is necessary to protect
borrowers from a possible lack of

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are able to alter their portfolio composition,
state usury laws thus tend to limit the total
amount of credit available to consumers
within affected states.

competition in lending markets-and from
the stronger bargaining position held by
lenders because of their large size and easier
access to information. Information on loan
rates, maturities, fees, and repayment terms is
costly for
to obtain, so that they
cannot easily shop around to obtain the most
favorable terms. Legislatures thus utilize
ceilings to limit lenders' ability to turn
possible bargaining advantages into high
interest rates and fees. In recent years,
however, other legislation (such as the Truth
in Lending Act) has aided consumers by
standardizing the statement of contractual
terms and by simplifying comparisons among
lending agreements, thereby eliminating
some of the supposed need for usury statutes.
Moreover, financial markets have become
more integrated and competitive over time,
so that consumers normally have many
borrowing options available to them.

Ceilings also induce institutions to tighten
their non-price terms of lending in order to
reduce loan volume and to lower costs. To
ration the dwindling supply of credit,
institutions will tighten credit standards,
allocate loans to existing customers, and limit
maximum loan sizes. Also, as a means of
reducing costs-especially loan losses and
administrative expenses-institutions will
allocate available credit to their most
credit-worthy, low-risk borrowers. Thus,
rather than insuring wide-scale availability of
credit at artificially low rates, binding usury
ceilings may simply guarantee availability of
credit to the "best" customers. Borrowers
who otherwise might qualify if institutions
could charge above-ceiling rates will be left
without credit.

Unintended effects
When market-determined interest rates soar
above statutory ceilings, usury laws
admittedly limit the price of credit. However,
ceilings also effectively limit the return to
lenders, making certain loans unprofitable
without affecting yields on other types of
lending. Limited yields on consumer loans
thus induce financial institutions to restrict
their consumer lending and also to tighten
credit standards on such loans.

Some depository institutions with heavy retai I
or consumer orientation may find it difficult
to switch from consumer lending into other
types of lending. Large investment in staff
training, marketing programs, and lending
faci Iities -not to mention legal barriersmake it very costly for institutions to switch
policy in this way, at least in the short-run.
Institutions may be willing occasionally to
take short-term losses on some loans in order
to preserve profitable long-term relationships
with "valued" customers. But now, with the
high cost of new consumer deposits (especially money-market certificates), usury
ceilings may make consumer lending even
more unprofitable than in the past.

Banks in particular have available a wide
array of lending opportunities, so that they
can adjusttheir assetand liability portfolios in
response to ceilings placed on consumerloan rates. For example, they may increase
their lending to the business community
(through direct loans or purchases of openmarket paper), to the government sector (via
purchases of new securities), or to other
commercial banks (through loans of funds in
the inter-bank Federal funds market). In many
cases, they lend such funds to out-of-state
corporations, governments, or financial
institutions. Or they may simply reduce their
total lending and their managed liabilities
accordingly. Because financial institutions

Credit availability
Recent large-bank data from the San Francisco (Twelfth) Federal Reserve District
provide support for this analysis. From the
third quarter of 1 979 to the first quarter of
1981 -a period of generally very high
market rates-outstanding consumer credit
actually declined in states with usury-law
limitations on consumer-lending rates. In
2

other states, consumer lending continued to
grow, even in the face of sluggish economic
conditions, high interest rates, and the
spring-1 980 credit-control program. Usury
ceilings may not account for all of this
difference in states' growth patterns, but they
undoubtedly explain a large part of it.

problem, however, since the discount rate
typically lags behind the market during
periods of rising market rates. Moreover, the
discount rate-as an administered, one-day,
risk-free secured loan rate-is often well
below market-determined rates.
In light of this partial solution, state and
Federal legislators have intensified their
efforts either to rewrite usury statutes or to
eliminate them altogether. Two Western
states with rigid rate ceilings, Washington
and Idaho, have just taken actions to
liberalize their usury statutes, while the third,
Oregon, is expected to do so soon.

In this 1979-81 period, total consumer loans
at large banks in Washington, Oregon, and
Idaho, where ceilings were wei! below
market rates, declined at a S.l-percent
annual rate. In dollar terms, their outstanding
consumer loans fell from $3.7 billion to $3.4
billion over this time-span, in quarterly
average terms. Meanwhile, average consumer loans at large banks in five other
Western states without usury ceilings rose at a
3.2-percent annual rate, despite all the
negative factors affecting consumer markets
atthattime.

Recent and proposed legislative changes may
result in higher fixed usury ceilings, variablerate usury ceilings or, in some cases, no
ceilings at all. But in most cases, ceilings will
now move with the market, rising and falling
with the general level of interest rates. During
periods of high interest rates, these changes
will keep consumer credit from "drying up"
as it did in the past. Moreover, a potential
borrower who cannot obtain a loan at an
artificially low rate may certainly prefer
paying a higher rate to not obtaining a loan at
all.

Usury-law changes
Recognizing the perverse impact of usury
ceilings on the availability of consumer
credit, Congress last year included several
provisions in the Monetary Control Act to
deal with this problem. First, the MeA
preempted state usury ceilings on mortgage
loans-unless states reinstate such ceilings
by April 1, 1983. In contrast, the Act did not
include an unlimited override of state ceilings
on consumer loans. Instead, it authorized
insured state-chartered banks and thriftsnational banks already had authorization
-to set consumer-loan rates at a maximum
of one percentage point above the basic
Federal Reserve discount rate. This
represented only a partial solution to the

Consumer Loan Growth
Large Western Banks
1979 III to 1981 I

Annual rate
of change (:;)

6

4

In a wider sense, elimination of consumercredit crunches should benefit not only consumers but also business activity generally in
affected states. Finally, the shift to floatingrate usury ceilings, or even total elimination
of ceilings, would be consistent with Congressional efforts to decontrol interest rates on
both consumer loans and deposits.
Gary C. Zimmerman

States (5) without
effective ceilings

t

2

o
-2
-4
-6
States with binding usury ceilings

3

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BANKING DATA-TWELFTHFEDERAL
RESERVE
DISTRICT
(Dollaramounts millions)
in

.

Selectedssets liabilities
A
and
large CommercialBanks
Loans
(gross,
adjusted) investments*
and
Loans
(gross,
adjusted) total#
Commercial industrial
and
Realestate
Loans individuals
to
Securities
loans
U.s. Treasury
securities*
Othersecurities*
Demanddeposits total#
Demanddeposits adjusted
Savings
deposits total
Timedeposits total#
Individuals,
part.& corp.
(Large
negotiable
CD's)
WeeklyAverages
of Daily Figures
MemberBankReserve
Position
Excess
Reserves )/Deficiency- )
(+
(
Borrowings
Netfreereserves )/Netborrowed( )
(+
-

Amount
Outstanding
6/17/81
149,637
127,799
37,921
52,629
22,958
1,592
6,425
15,413
40,730
27,869
30,187
80,019
70,969
30,688
Weekended
6/17/81
n.a.
135
n.a.

Change
Change
from
yearago
from
Dollar
Percent
6/10/81
- 333
9.3
12,673
10.7
12,361
214
13.4
4,487
350
12.6
5,876
118
3.9
30
920
57.0
578
83
1.2
78
18
1.6
238
101
- 2,596
- 6.0
923
2,893
- 9.4
-1,355
- 142
9.5
2,612
- 312
25.1
16,069
- 194
28.9
15,919
8,009
35.3
393
Comparable
Weekended
year-ago
period
6/10/81
n.a.
173
n.a.

- 73
1
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* Excludes
tradingaccountsecurities.
# Includes
itemsnot shownseparately.
Editorialcomments
maybe addressed the editor (William Burke) to the author.... Freecopies this
to
or
of
andother Federal
Reserve
publications beobtained callingor writing thePublicInformation
can
by
Section,
Federal
Reserve
Bankof SanFrancisco, Box7702,SanFrancisco
P.O.
94120.Phone
(415)544-2184.