ISE02/18-19

• In Hong Kong, individual sub-prime borrowers with lower creditworthiness and greater challenges in securing bank loans usually turn to non-bank lenders to tide over their financial difficulties.^{1Legend symbol denoting Subprime lending means loans extended to people with lower ability to repay or questionable track records. These subprime borrowers are usually subject to higher interest rates due to higher default risk. In 2017, money lenders in Hong Kong reportedly extended 97% of their personal loans to borrowers below the better-than-prime rating. See TransUnion (2017).} Over the past five years, demand for such individual loans has strengthened significantly, as manifested in a strong growth of some 40% in the outstanding loan balance of the non-bank money lending industry to HK$30.9 billion in 2017.^{2Legend symbol denoting According to a market research agency, the outstanding loan balance of the money lending industry is estimated to have grown by 41% in five years to HK$30.9 billion in 2017. Relative to the overall amount of personal loans (including mortgage loans) of HK$1,878 billion in the banking sector, it represented a ratio of just about 2%. See Frost and Sullivan (2018), as cited in Harmony Finance Group (2018).} The number of non-bank lenders has even more than doubled over the same period, rising by 108% to 1 994 in 2017.
• While non-bank lenders are regulated under the Money Lenders Ordinance ("MLO") enacted in 1980, it does not effectively deal with some of the improper business practices of money lenders, such as unaffordable interest rates, aggressive marketing practices leading to over-indebtedness of borrowers and improper debt collection methods.^{3Legend symbol denoting In debt collection, some malpractices are already considered to be criminal activities (e.g. arson, assault and robbery) and they can be sanctioned by law. However, other malpractices such as telephone nuisances, repeated personal visits, and posting of debt collection notices may not constitute criminal offences.} Although the Government has stepped up measures to tackle malpractices of financial intermediaries in relation to money lending since 2016, Members have repeatedly called for a comprehensive review of MLO for enhanced consumer protection.^{4Legend symbol denoting On 5 February 2018, the subject of "Review of the effectiveness of the new regulatory measures to tackle money lending-related malpractices" was discussed at the Panel of Financial Services. See Legislative Council Secretariat (2018a) and (2018b).}
• In Japan, individual borrowers used to suffer from similar malpractices of money lenders, but decades of regulatory reforms since the 1980s seem to have effectively lowered the interest rates chargeable and trimmed the size of such debts. Moreover, such reforms in Japan are acclaimed as a good case of consumer protection.^{5Legend symbol denoting Organisation for Economic Co-operation and Development (2012).} This issue of Essentials first reviews regulatory developments of money lending in Hong Kong, followed by an account of major regulatory reforms in Japan.

Regulatory developments on money lending in Hong Kong

• Before the emergence of modern banking by around the 19th century, money lenders used to be the last resort for those with financial needs, but anti-usury laws were enacted in many places to offer certain consumer protection (e.g. setting an interest rate ceiling). In line with this global trend, the Hong Kong Government enacted MLO in 1911, requiring mandatory registration of non-deposit-taking lenders. However, many practices in relation to money lending did not come under the ambit of MLO. The Government could neither refuse registration of any lender, nor impose adequate penalties on lenders charging excessively high interest rates.
• Since the 1970s, while personal loans extended by commercial banks have become more common, money lenders still play a key role in subprime lending which is deemed to be more risky by banks. As some non-bank lenders charged interest rates as high as 100%–350% in the late 1970s, there were increased complaints over their improper practices. In 1980, the Government enacted a new MLO to repeal the old one, with the following legislative features which are still in effect by now:^{6Legend symbol denoting Official Record of Proceedings of the Legislative Council (1980).}
  
  

  (a)	Licensing system: Non-bank lenders must obtain a licence granted by the Licensing Court. The Registrar of Money Lenders is authorized to process lenders' applications, and can raise objections to the Licensing Court if the applications do not meet specified standards. The Hong Kong Police Force is responsible for investigating complaints against usury and improper debt collection practices;
  (b)	Interest rate ceiling: The new MLO specifies an interest rate ceiling of 60% per annum. Any interest rate exceeding this threshold constitutes a criminal offence, subject to a maximum penalty of HK$5 million and 10 years of imprisonment. If the annual interest rate is below 60% but exceeds 48%, it is presumed to be extortionate and the courts have the power to reopen the transaction and adjust the terms. Incidentally, commercial banks are subject to similar interest rate regulations;7Legend symbol denoting Banks are exempted from the Money Lenders Ordinance ("MLO"), but the Code of Banking Practice stipulates that banks have to follow the limits on interest rates set in MLO. and
  (c)	Prohibition of additional charges: To prevent money lenders from circumventing the interest rate regulation, MLO prohibits money lenders from charging other kinds of fees.

• In the early 2010s, some money lenders attempted to evade the interest rate ceiling by charging "loan arrangement fees" through its "separate" yet associated financial intermediaries, as manifested in the 79% surge in the number of complaints lodged to the Consumer Council against these financial intermediaries from the previous year to 134 cases in 2015. This prompted the Government to take a "four-pronged approach" in 2016 to tackle this sort of malpractices. They included: (a) stepping up police enforcement; (b) enhancing public education over the risks of lending through such intermediaries; (c) improving provision of advisory services to those in financial distress; and (d) imposing more stringent licensing conditions on money lenders under MLO with enhanced enforcement as from December 2016.^{8Legend symbol denoting Under the additional licensing conditions, money lenders must: (a) disclose the intermediaries they have appointed to the public; (b) ensure that the borrower has only engaged an appointed intermediary; (c) take appropriate steps to ensure that the intermediary does not charge fees on the borrower; and (d) include the risk-warning message "Warning: You have to repay your loans. Don't pay any intermediaries." in all advertisements.} These measures appeared to be quite effective, resulting in a 76% plunge in the police reports against such intermediaries in 2017.^{9Legend symbol denoting Financial Services and the Treasury Bureau (2018).}
• That said, there are still outstanding issues regarding business malpractices of non-bank lenders. First, aggressive marketing campaigns of non-bank lenders are alleged to have led to excessive borrowing by sub-prime borrowers, especially those in the lower income strata with limited knowledge of prudent financial planning. For example, some advertisements emphasise that loans could be made even without income proof. Secondly, there are grave concerns over prevalence of improper practices in debt collection (e.g. telephone nuisances, repeated personal visits and public posting of debt collection notices), although such practices are not classified as illegal at present. In spite of recommendations made by the the Law Reform Commission in 2002, the Government refused to regulate such debt collection malpractices, claiming that other legal provisions could "guard against different kinds of illegal debt collection practices".^{10Legend symbol denoting GovHK (2016) and (2017).} As a matter of fact, reports of non-criminal malpractices in debt collection increased by 59% in 17 years to 9 723 cases in 2016.

Regulatory reforms on malpractices of money lenders in Japan

• In line with the global trend, Japan has a long history of usury laws back to at least the 12th century. Fast forward to the more contemporary years, the Act Regulating the Receipt of Contributions, the Receipt of Deposits, and Interest Rates was enacted in 1954.^{11Legend symbol denoting At the same time, Japan passed the Interest Rate Restriction Act ("IRRA") with a "voluntary" interest rate cap at 20% per annum. Interest charged above the cap could be claimed back by borrowers in courts. However, this law was commonly deemed less binding than the Act Regulating the Receipt of Contributions, the Receipt of Deposits, and Interest Rates.} The gist of the legislation was to put a statutory cap on the interest rate at 109.5% in such lending, compared with the prevalence of market rates as high as over 200% by then. Interest rates breaching the limit would be subject to criminal penalties. However, this interest rate ceiling was still too high to relieve the debt problems (e.g. excessive borrowing at high costs and aggressive debt collection methods) in Japanese society. Taking Fukuoka Prefecture as an example, 54 debt-related suicide cases were recorded in a single year of 1982 alone, and 80% were attributable to problems with money lenders.
• In response, Japan enacted the Money Lending Business Act in 1983, requiring mandatory registration of non-bank money lenders on the one hand, and revising downwards the statutory cap on interest rates by phases over the next 17-year period on the other. The interest rate ceiling had then been lowered continuously to 73% in 1983, 54.75% in 1986, 40.004% in 1991, and 29.2% in 2000. Paradoxically, lower interest rates, coupled with aggressive marketing campaigns of lenders, contributed to a further steady rise in the outstanding loan value in the next two decades, by a cumulative 217% from 1988 to a peak of ¥20.9 trillion (HK$1.4 trillion) in 2006. Against a much deteriorated macroeconomic environment amidst the "lost two decades" in Japan, bankruptcy filings surged by 1536% to 184 422 during 1990-2005, while debt-related suicide cases also increased steeply by 525% to 7 956 over the same period.^{12Legend symbol denoting Pardieck, A. (2008).}
• The Japanese government stepped up regulatory reforms to address the debt problems, introducing amendments through the Black Market Finance Countermeasures Act in 2003 and further revisions in 2006. The following measures are introduced under the new legislations:
  
  

  (a)	Lowering of borrowing costs: The statutory cap on interest rates would be further reduced to 20% by 2010. Money lenders in breach of the rule would be subject to a maximum penalty of 10 years' imprisonment and a fine of ¥30 million (HK$2.1 million);13Legend symbol denoting For an interest rate exceeding 20% per annum, the money lender is subject to a maximum of five years' imprisonment and a fine of ¥10 million (HK$695,000). If the rate exceeds 109.5%, the maximum penalty is 10 years' imprisonment and a fine of ¥30 million (HK$2.1 million). In addition, brokerage fees were capped at 5% of the loan. See Articles 4 and 5 of the Act Regulating the Receipt of Contributions, the Receipt of Deposits, and Interest Rates.
  (b)	Mechanism to prevent excessive lending to individuals: The amendments in 2006 facilitate aggregate debt control of borrowers. First, lenders must share the debt records of individual borrowers with the Designated Credit Bureaus established by the government. Secondly, lenders cannot lend to those borrowers whose total loans (excluding bank loans and secured loans) exceed one-third of their annual income. Thirdly, for loans over ¥500,000 (HK$34,750), lenders must obtain borrowers' tax documents as the income proof;14Legend symbol denoting Articles 13 and 41 of Money Lending Business Act.
  (c)	Regulation of advertisements: Lenders need to include the actual interest rate in advertisements. The law also prohibits misleading representation and advertisements aiming at borrowers without an ability to repay;15Legend symbol denoting Articles 15 and 16 of Money Lending Business Act.
  (d)	Restrictions of debt collection malpractices: The amendment in 2003 prohibits malicious debt collection practices, such as debt collection at night (during 9:00 pm-8:00 am) without grounds, putting up posters, and making calls or visits to the borrower's workplace;16Legend symbol denoting Article 21 of Money Lending Business Act.
  (e)	Tightening the licensing regime: Measures have been taken to forbid registration by those money lenders associated with organized crimes. Lenders also need to hold assets of at least ¥50 million (HK$3.5 million) and hire registered compliance officers who have passed the examination administered by the Japanese government in branches to ensure proper practices. The Japanese government can order board members of a lending firm to be dismissed in case of law infringement;17Legend symbol denoting Articles 6, 12 and 24 of Money Lending Business Act. and
  (f)	Strengthening self-regulation: Lenders need to join trade associations which are under the supervision of the Financial Services Agency ("FSA"). These associations have established self-regulatory rules on (i) frequency of advertising; (ii) prevention of excessive lending; and (iii) malicious debt collection practices.18Legend symbol denoting Articles 25-41 of Money Lending Business Act.

• These measures seemed to have effectively addressed the malpractices of money lenders. First, the number of complaints against malpractices of money lenders lodged to FSA plunged from the peak of 77 433 in 2003 to only 7 676 in 2017, with a cumulative decline of 90%. Secondly, the mechanism of aggregate debt control helped reduce the number of multi-debt holders (i.e. those with at least five loans) by 48% to some 44 000 during 2010-2012, as well as the number of personal bankruptcies by 65% to 63 856 during 2005-2015. Thirdly, the number of non-bank money lenders in Japan plunged by 88% to 1 770 during 2006-2018, along with a 69% decline in their outstanding consumer loans to ¥6.5 trillion (HK$452 billion).^{19Legend symbol denoting Financial Services Agency (2018).}

Observations

• Similar to Hong Kong, Japanese borrowers used to suffer from malpractices in the money lending business. However, decades of regulatory reforms in Japan since 1983 appear to have addressed the community concerns over high borrowing costs, excessive lending, improper debt collection practices and other malpractices of money lenders.

Prepared by Germaine LAU
Research Office
Information Services Division
Legislative Council Secretariat
21 November 2018