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IAI Actuarial Core Principles · Business Economics · Government intervention in a market

A regulator caps the interest rate on small microfinance loans below the market-clearing rate. Which outcome is the most likely consequence for borrowers?

Credit is rationed. A cap below the market-clearing rate acts as a binding price ceiling, so loan demand exceeds supply, lenders lend less and exclude riskier borrowers, who may then turn to informal sources.

  1. AMore lending as borrowing becomes cheaper for all
  2. BRationing of credit, with some borrowers excluded from formal loansCorrect
  3. CA surplus of loanable funds at the capped rate
  4. DLenders raise the cap voluntarily
  5. No change because interest rates are set by demand only

Explanation

An interest cap is a price ceiling on credit. At the lower rate, demand for loans exceeds the amount lenders are willing to supply, so lenders ration credit, often excluding riskier borrowers who may turn to informal moneylenders. A surplus of funds would occur only with a floor.

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