August 9e2022, the Department of Finance Canada issued a consultation document (there “Paper”) to solicit comments from stakeholders, various industry associations, consumer groups and members of the public regarding the maximum interest rate for the criminal code (there “Coded”) and the provision of high cost installment loans in Canada.
Although the government has not yet proposed a new criminal interest rate, the purpose of the document is to better understand the impact that a rate reduction can have on the availability of credit for Canadians. The provisions of the Code on payday loans are not part of the consultation as they are exempt from the maximum interest rate under the Code and are instead regulated at the provincial level.
The Maximum Interest Rate and the Criminal Code
Section 347 of the Code was first introduced in 1980, to cap the maximum interest rate charged to consumers at 60%. At the time, the criminal interest rate was established to combat predatory lending that relied on intimidation and violence to enforce repayment, and was never intended as a financial instrument to protect consumers against high-cost loans offered by established players. The original rationale for the 60% maximum interest rate was to provide an objective standard that spared prosecutors from having to prove that violence or intimidation was associated with the execution of the loan.
The Code makes it an offense to: (1) enter into an agreement or arrangement to receive interest at a rate greater than 60%; and (2) actually receive interest at a rate greater than 60%. The Code defines “interest” as the aggregate of all fees and expenses, including fees, fines, penalties or commissions, including compound interest at an effective annual rate. What it does not include in this definition are additional costs such as insurance, overdraft or fees when discharging a mortgage. The Supreme Court of Canada has provided a more comprehensive definition of the term “interest” in the Code, whereby the determination of whether something is an “interest” depends on the substance of the transaction.
High cost installment loans and maximum interest rate
The paper primarily focuses on high-cost installment loans, which are personal loans that give a borrower a fixed sum of money (the principal) that is repaid with interest in installments over an agreed period of time, usually several months to several years.
The Financial Consumer Agency of Canada (“FCAC”) recently conducted a study in which they found that 44% of consumers who had taken out high-cost credit said they had taken out a high-cost installment loan in 2020, making these products the highest-cost loan product most widely held in Canada.
The document identifies four general categories for which the government is seeking comments:
- How changes in market rates and pricing risk are correlated
Despite recent increases, the Bank of Canada’s overnight rate has been on a general downward trend since the 1980s. The spread between the Bank of Canada’s overnight rate and the criminal interest is almost 60%, which is a much larger difference than was expected when the rate was originally introduced. Therefore, the government is interested in understanding whether the current practices of alternative high-cost lenders reflect the actual credit risk of borrowers, or whether current rates on high-cost products simply reflect compliance with the maximum interest rate provided for in the Coded.
- How High-Cost Rates and Installment Loans Can Affect Access to Credit
Vulnerable populations, including low-income households, those with little education, single parents and Indigenous Canadians are more likely to turn to other lenders who offer high-cost installment loans, as they may have difficulty in accessing traditional financial institutions. Therefore, the government wishes to understand whether a significant drop in the criminal interest rate will affect the availability of credit for financially vulnerable Canadians.
- Impact on other loan products
The criminal interest rate applies to most loan products in Canada. Therefore, the government is also interested in understanding the impact of the criminal interest rate reduction on other lending products, such as lines of credit, credit cards, certain auto loans, auto title loans and short-term loan products (eg bridge financing).
- Consumer Education
Some consumers often choose high-cost loan products without understanding the impact these products can have on their financial well-being. Therefore, the government is interested in understanding how it can work with stakeholders to educate vulnerable Canadians about the potential costs and risks of high-cost loan products.
Based on the four general categories above, the paper broke down the main survey into seven questions, presented below for convenience:
- Should the criminal interest rate be set at a fixed level or tied to market conditions?
- To what extent does the interest rate charged by alternative lenders on high-cost installment loans reflect the creditworthiness of the borrower?
- What are the reasons why financial consumers are accessing high cost installment loans?
- What are the impacts of high-cost installment loans on the financial well-being and financial resilience of Canadians?
- What impact would lowering the criminal interest rate have on the availability of credit for financial consumers who use high-cost installment loans? Would lowering this rate have negative implications for financial consumers, including loss or reduced access to credit?
- What impact would lowering the criminal interest rate have on credit products other than high-cost installment loans?
- How could the Government of Canada, including FCAC, improve financial education and awareness about high-cost installment loans to further empower and protect Canadians as they make informed financial decisions ?
Stakeholders can provide comments on the document until October 7, 2022 by emailing [email protected] with “Predatory Lending Consultation” in the subject line, or by mail.