Interest Rate Caps and Bank Loan Supply: Locking out the Small Borrower in the Great Depression

We examine the effects of changes in an interest rate cap on small loan brokers in New Jersey during the Great Depression. Using newly constructed data on brokers and banks, we find that small loans declined sharply when the cap was lowered, and despite worsening economic conditions, they rebounded when the cap was raised back up. Consumers could not obtain alternative credit from banks, effectively shutting them out of the market. The cap had a permanent impact on the small loan market due to the large number of broker closures, thereby further reducing the availability of small loans and increasing market concentration. Our findings highlight the fundamental trade-off faced by policymakers: strict rate caps may protect borrowers from predatory lending but can eliminate necessary credit options for vulnerable populations.