PREDATORY LENDING PRACTICE SHOULD BE BANNED:

THE CRITICAL ISSUE

FACING BY FINANCIAL SERVICES INDUSTRY

BY

WAN AHMAD MARWAN YAACOB

0713725

KULLIYAH OF ECONOMICS AND MANAGEMENT SCIENCES

MADAM ZARINAH JAN YUSOF KHAN

SECTION 37

INTERNATIONAL ISLAMIC UNIVERSITY

MALAYSIA

19 OCTOBER 2009
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Running head: PREDATORY LENDING PRACTICE…

Predatory Lending Practices Should Be Banned: The Critical Issue

Facing by Financial Services Industry

Wan Ahmad Marwan bin Yaacob (0713725)

Kulliyyah of Economics and Management Sciences,

International Islamic University Malaysia.

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Abstract

This paper seeks to highlight the issue of predatory lending that has become one of the most

critical policy issue faced by the financial services industries. The focus will be given into the

reason why predatory lending should be prohibited from the financial services industry. The

predatory lending is argued as a tool to oppress the consumers, threat violence to society, and

violate the Islamic fundamental and laws. In preparing this paper, Internet papers, books, articles,

newspapers, journals, and discussions were used. Last of all, it is hoped that government and

financial agencies will find the effective measures in order to prevent this kind of practices from

spreading in society and teach the public concerning the abusive of predatory lending.
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TABLE OF CONTENTS

Page

Abstract 3

I Introduction 5

II Arguments

Argument 1 Oppress the borrower 7

Argument 2 Threat violence to society 9

Argument 3 Islamic perspective 11

Counter-argument 13

III Conclusion 15

References 17

Glossary
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Introduction

Predatory lending has become one of the most critical policy issues faced by the financial

services industry. The term “predatory lending” generally refers to subprime lending practices

that are considered to be harmful and abusive to borrowers. While there is no universal

agreement on what practices should be considered predatory, those most often cited as predatory

lending include making unaffordable loans based on the collateral rather than on the ability of

borrower to repay the loan, including a borrower to repeatedly refinance a mortgage for no other

reason than to generate additional points and fees, and engaging in fraud and deception to

conceal from unsuspecting or unsophisticated borrowers the true nature and cost of a loan

(Gramlich, 2000) (Fisher, 2005). Predatory lending typically occurs on loans backed by some

kind of collateral, such as a car or house, so that if the borrower defaults on the loan, the lender

can repossess or foreclose and profit by selling the repossessed or foreclosed property. Lenders

may be accused of tricking a borrower into believing that an interest rate is lower than it actually

is, or that the borrower's ability to pay is greater than it actually is. The lender, or agents of the

lender, may get profit from repossession or foreclosure on the collateral. There are many lending

practices which have been called abusive and labeled with the term "predatory lending" such as

unjustified risk-based pricing, single-premium credit insurance, failure to present the loan price

as negotiable, short-term loans with disproportionally high fees, loan flipping, and servicing

agent and securitization abuses. Even though predatory lending was becoming a global problem,

some people looked the other way and did nothing to protect the borrowers. They claim that

predatory lending is not a crime and it is a kind of business that practiced by capitalists in

conventional economics. However, I strongly agree with the topic that predatory lending

practices should be banned because these kind of practices are giving a lot of harmful to
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people and the economy rather than a little helping to the society in terms of oppressing the

borrowers, threatening the security and safety of society and practicing totally against the

Islamic laws and teachings.

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Argument 1 - Oppressing the borrowers

Firstly, predatory lending practices should be banned because these practices are

oppressing the borrowers. Normally, predatory lenders charge different interest rate depending

on the types of the loan and some predatory lenders charge about 40% per fortnight with

constantly compounding interest. Consequently, most borrowers become trapped by their loans

and are unable to pay off the principal and will be dragged on to become debt peon. Predatory

lenders use quite a number of different abusive practices such as insurance packing, bait and

switch, fraud, prepayment penalties, equity stripping, balloon payment, and loan flipping when

putting together a subprime loan and their possible targets are the elderly, low-income, or

minority homeowners (Quercia, Stegman and Davis, 2003) (Legal Match, 2009).

Carr and Kolluri, (2001) explain the situations of predatory lending when they write

about the research of predatory mortgage loan in the United States,

The abuse of subprime loans in minority neighborhoods is evidenced by the government

study in an African-American neighborhood showing over 51% of the refinanced

mortgages being subprime, compared to only 9% in predominantly white neighborhoods.

The borrowers are often subjected to very aggressive sales tactics to push them or force

them into refinancing when it is not in their best interest” (p. 6).

Besides, refinanced mortgage can be packed with excessive fees or unnecessary fees. A

regular mortgage usually will have loan fees below 1% of the total loan amount. However, a

predatory mortgage can have loan fees in excess of 5%. These excessive costs are tucked into the

loan amount so the lender can easily cover up them, and these fees can put thousands of the

homeowner's money into the predator's pockets (Carr and Kolluri, 2001).
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Moreover, predatory lenders often add insurance and other unnecessary products to the

loan amount. The insurance that they either insist on or coerce the borrower into buying can

include regular mortgage insurance such as fire and hazard insurance, life insurance, disability

insurance, homeowner's insurance, and health insurance etc. To make things worse, the lenders

extended the insurance to include all family members, not just the borrowers themselves and the

premium for these items is also added onto the loan amount where the cost is not easily spotted

by the borrower. As the result, the predatory lenders earn large commissions every year on the

premiums paid (Carr and Kolluri, 2001).

Important to note, normally, the borrowers who approach the predatory lenders are facing

the critical financial situation. Most of them being a person who need money very urgently, so,

they have no choice but would approach the predatory lenders even though they know the risk

which will appear later. This is because, either the chances of getting financial aids from legal

financial institutions, families, and relatives are very limited, or the time frame to get approval

for their application is quite long. Finally, the borrower will be trap in the hand of the predatory

lenders. Thus, it is very important to curb this problem now by banning all the predatory lenders

whether they are legal or illegal.

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Argument 2 - Threaten the security and safety of the society

Secondly, predatory lending should be banned because these practices threaten the

security and safety of the society. Besides charging a very high interest rate, predatory lenders

who are associated with organized crime syndicates also frequently threaten violence toward the

borrowers who fail to pay in time. For instance, a predatory lender threats of violence by forcing

a family into prostitution in United Kingdom. The victim had originally borrowed £1,000 from

the lender. Because the victim is unable to pay the agreed monthly sum, his debt was sold on to

another lender who demanded immediate repayment of the whole amount, plus extortionate

penalties. Intense were the threats of violence to him and his family that his wife and daughter

took the terrible decision to sell sex (Bahra and Bennett, 2009). Besides the victims, the British

government estimated about 165,000 people turn to predatory lenders to get loans. Other

research from the New Local Government Network puts the figure at 200,000. Mister

Richardson, who runs Operation Shark Bait, a multi-agency program that includes the police,

financial investigators and members of his team, said that it was typical of the cases that

investigated by him and his colleagues (Bahra and Bennett, 2009).

In Malaysia and Singapore, predatory lenders also use violence to warn or force the

borrowers to payback their loans. There are many kinds of violence done by the predatory

lenders such as beating the borrowers, destroying their property, hung head of pig outside the

borrower’s home, steal the items of borrowers worth the loan or in some extreme case, due to the

constantly oppressed by the predatory lender, the victims was forced to commit suicide (The

Star, 2007). An article published in nation headlines section of The Star (2009) under the title

“Loan sharks who held trader end up in custody” stated:

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Four loan sharks were nabbed by the police while another escaped after they detained a

furniture shop owner and demanded payment for a loan…The victim’s wife met the

suspects and her husband…ramming a police patrol vehicle in the process…adding that

the case…attempted murder and Section 385 of the same Code for extortion…a manhunt

for the escaped suspect has been launched (p. 1).

This article is an example of cases reported in mass media and told us about the danger of

predatory lending practices to the public and the effect of these kind of practices to the

harmonious and safeness of the society. Besides Malaysia and Singapore, these practices also

common in most of financial businesses at the global level such as in Japan, China, Hong Kong,

New Zealand and European countries. So, in order to stop all these problems, the predatory

lending practices should be banned globally and the predatory lending laws need to integrate into

the legal systems of every country in the world.

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Islamic Perspective

Thirdly, predatory lending practices should be banned based on Islamic perspective. The

practices of predatory lending are totally against the Islamic laws and teaching. First of all, the

predatory lending practices have the element of usury in the transaction and it is against the

command of Allah in the Surah Al-Baqarah verse 275 and those who charge usury are in the

same position as those controlled by the devil's influence. This is because they claim that usury is

the same as commerce. However, Allah has said clearly in Surah Al-Baqarah verse 275, “God

permits commerce, and prohibits usury” (Al-Baqarah 2:275). Thus, whoever heeds this

commandment from his Lord, and refrains from usury, he may keep his past earnings, and his

judgment rests with God. As for those who persist in usury, they incur Hell, wherein they abide

forever. Usury originally meant the charging of interest on loans. This would have included

charging a fee for the use of money. After countries legislated to limit the rate of interest on

loans, usury came to mean the interest above the lawful rate. In common usage today, the word

means the charging of unreasonable or relatively high rates of interest.

In addition, the predatory lending practices also ignore the encouragement of Allah for

Muslims to help each other through benevolent loan as stated in Al-Qur’an: Surah Al-Hadid,

verse 11. “Who is he that will loan to Allah a beautiful loan? For (Allah) will increase it

manifold to his credit, and he will have (besides) a liberal reward (Al-Hadid 57:11)”. Benevolent

loan is a loan extended on a goodwill basis, and the debtor is only required to repay the amount

borrowed (Sariff, 2008). However, the debtor may, at his or her discretion, pay an extra amount

beyond the principal amount of the loan (without promising it) as a token of appreciation to the

creditor. In the case that the debtor does not pay an extra amount to the creditor, this transaction
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is a true interest-free loan. Some Muslims consider this to be the only type of loan that does not

violate the prohibition on riba’, since it is the one type of loan that truly does not compensate the

creditor for the time value of money. So, as a Muslim that obey to the word of Allah, we should

ban all the transactions that include riba’ and change it by using the Islamic financial transactions

that approved by the Islamic scholars and the Shariah councils such as sales of al-amanah, al-

ijarah, bai’ bi saman al-ajil, al-wadiah, takaful, qar al-hasssan (benevolent loan), al-rahn, al-

hiwalah etc.
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Counter-argument

Opponents of this idea maintain that predatory lending practices should not be banned.

They put forward this idea because they claim this practice is not a crime. They have the opinion

that the concepts of fairness and transparency applied just to borrowers but not to lenders.

According to Miller (2008), in his article at http://www.realtytimes.com,“Guest what? Predatory

lending is not a crime”, he claim: “….but no predatory lender will ever be persecuted by the

federal government. The reason? Predatory lending is not a federal crime. Don't believe it? Just

take a look at the annual statistics for financial crimes. Not a single case of predatory lending….”

(p. 1).

Nevertheless, the predatory lending practices are still crimes even though they are not

included in the annual statistics for financial crimes until the date. This is because the limitation

of existing data sets about predatory lending practices, which are not available to the wider

research community for validation or replication. Simply put, there is no comprehensive, broadly

accessible census of subprime lending available to the research and lending communities

(Quercia, Stegman and Davis, 2004). That is why predatory lending is not declaring a crime and

not put in the annual statistics for financial crimes.

Moreover, after the United States changed the administration from President George W.

Bush to President Barak Obama, they also had changed the policy of taking no action on

predatory lenders to the policy of helping the consumers and borrowers from being trapped by

predatory lenders (Spitzer, 2008). The Obama administration has altered The Truth in Lending

Act (TILA) in order to protect the consumers and borrowers and improve the faith of public to

the lending system that applied the concept of fairness and transparency to borrowers and
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lenders. In addition, predatory lenders in some countries are more extreme and dangerous.

Besides abuse or threaten unfair to borrowers by charging excessive interest rates, they also

frequently threaten violence to the borrowers and their family in order to force the borrowers pay

back the loan. Thus, it is important to do something about this before it gets worse.
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Conclusion

In conclusion, I firmly believe that predatory lending practices should be banned because

the practices threat the consumers and borrowers with extravagant high interest rates, use

violence to the societies, and against the Islamic fundamental. The issue of predatory lending is,

for good reason, an issue of global concern. Yet, while there is strong consensus to act, there is

enormous inertia in taking the definitive action that might impact any type lending service. Part

of the failure to aggressively address predatory lending is based on a legitimate concern that

price controls and blanket prohibitions of individual loan features could negatively impact

market segments in unintended ways. Moreover, predatory lending is merely the extreme end of

a spectrum of abusive, unscrupulous, and costly financial services practices that dominate lower-

income and minority communities. Placing caps on certain practices and eliminating certain

other behaviors would go a long way to removing some of the most destructive wealth stripping

activities from the financial markets. But limitations, restrictions, and caps on different financial

services practices are not sufficient in order to address the broader issue of market failure that

plagues these communities.

That broader challenge requires positive actions and initiatives. Lower-income and

minority communities need high-quality, low-cost financial services adapted to their low-income

and low-wealth circumstances. At the same time, there are real limits on the extent of consumer

financial education that can help the borrowers whose are the focus of fraudulent professionals.

For example, mortgage loan documents consist of dozens of provisions written in extremely

complex, confusing, and technical legal language. Therefore, predatory lenders target lower-

income and minority borrowers with limited education and vulnerable elderly consumers
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specifically because they cannot reasonably protect themselves. To expect that financially

consumers that are exposed to the risks can reasonably review, understand, and challenge

specific requirements in many legal documents that are regularly involved in the mortgage

lending process is a highly unreasonable expectation.

So, the government agencies have to play their important roles in order to educate the

public, share the data of financial information with the financial institutions and enact the new

laws or change the existing laws to prevent these kind of practices from spreading in the

economy whether in microeconomics or macroeconomics. Part of that, the financial authorities

such as Ministry of Finance and central bank should insist the financial institution to create and

apply more lenient terms and conditions which will benefit both parties.
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References

‘Abdullah Yusuf Ali. (1994). The Holy Qur’an: Text and Translation. Kuala Lumpur: Islamic

Book Trust.

Al-Quran, Surah Al-Baqarah: 275.

Al-Quran, Surah Al-Hadid: 11.

Bahra, P. & Bennett, R. (August 7, 2009). Loan sharks threats of violence forced family into

prostitution. The Times, p. 24.

Legal Match. Find The Right Lawyer Now: Predatory Lending Claim Lawyers. (2009).

Retrieved September 24, 2009 from http://www.legalmatch.com.

Fisher, J. J. (2005). What Is a Predatory Lender? Retrieved August 4, 2009, from

http://www.zeromillion.com.

Friedman, T.L. (2006). The World Is Flat. America and the Flat World. Penguin Books.

Gramlich, E.M. (December 6, 2000). Remark at the Federal Bank of Philadelphia, Community

and Consumer Affairs Department. Conference on Predatory Lending, Philadelphia.

Ho, G. & Pennington, A. (December 20, 2005). The impact of local predatory lending laws on

the flow of subprime credit. Journal of Urban Economics. Volume 60, Issue 2, September

2006, Pages 210-228. Retrieved August 4, 2009 from http://www. sciencedirect.com.

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References

Loan sharks who held trader end up in custody. (July 26, 2009). “National Headlines” section.

The Star, p. 1.

Miller, P.G. (May 7, 2008). Guest What? Predatory Lending Is Not A Crime. Retrieved from

http//www.realtytimes.com/.

Quercia, R.G, Stegman, M.A & Davis, W.R. (2003). The impact of North Carolina’s

Anti-Predatory Lending Law: A descriptive assessment. Centre for Community

Capitalism, University of North Carolina at Chapel Hill.

Sariff, S. (2008). Fiqh for Economists II. Benevolent loan. Economics Department, Kulliyyah of

Economics and Management Sciences, International Islamic University Malaysia.

Thomas, A. (2009). Predatory lending laws. Retrieved August 4, 2009 from

http://www.httparticles.com.

What Is Predatory Lending?. (2009). Retrieved August 4, 2009 from

http:www.mortgagenewsdaily.com/.
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Glossary

Market segments – a group of consumers who respond in a similar way to a given set of

marketing efforts.

Bait and Switch - Lender offers one set of terms when the borrower applies for a loan, but

changes them for worse terms at the time of the loan's closing

Fraud - Concealment and fraud by the lender of the loan's terms

Prepayment penalties - Lender charges exorbitant fees if the borrower pays off the loan earlier or

refinances

Loan flipping - Lender provides unnecessary refinancing of the loan with no apparent benefits to

the borrower

Balloon payments - A loan with an outrageously high payment due at the end of the loan's

lifetime

Equity Stripping - Lender makes a loan based on the borrower's home equity, regardless of

borrower's ability to repay the loan

Insurance Packing - A loan that charges borrowers for services that a borrower does not need or

want.

Riba’ - Usury

Sales of al-Amanah – Sales based on trust of the revealed information (cost and profit).

Al-Ijarah – Leasing based on Islamic financing systems.

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Al-Bai’ Bithaman Ajil - Deferred Payment

Al-Wadiah - Current Account based on Islamic financing systems.

Takaful – Islamic Insurance

Al-Rahn – Mortgage based on Islamic financing systems.

Al-Hiwalah - Remittance based on Islamic financing systems.

The Truth in Lending Act (TILA) - assures disclosure of credit terms