Only twice as much: A rule for regulating lenders

Abstract

Present‐day policies aiming to improve the performance of credit markets, such as group lending or creation of collateral, typically aim to change incentives for borrowers. In contrast, premodern credit market interventions, such as usury laws, often targeted the behavior of lenders. We describe and analyze a norm that, although widespread, has escaped scholarly attention: a ceiling on interest accumulation, which limits it to the amount of the original principal. We interpret this rule, which is found in Hindu, Roman, and Chinese legal traditions, as giving lenders the incentive to find more capable borrowers, who will be able to repay early, thereby improving the allocation of capital. We document the consistency between our explanation and the rationale offered by the policy makers.