Authors: Oliver Pahnecke & Juan Pablo Bohoslavsky
This Article proposes an innovative and human rights-based interpretation of interest rates applied to public and private loans where interest rate and risk premium are adjusted after the full payment of the principal.
Risky borrowers pay more for the same loan than low-risk clients due to risk-weighted interest rates that are based on the absence or the quality of collateral. While this approach treats collateral and risk premium as exchangeable, it is only the collateral that is returned at the end of the contract; the risk premium is not. The practice of charging a risk premium on top of the prime rate is legally justified since it serves as a protection of the lender’s property in a riskier environment by accelerating the return of the principal.
But the Article argues that the price difference loses its economic and legal justification once the risk premium has fulfilled its purpose of ensuring the payment of the principal. Beyond that point, the risk premium becomes a form of discrimination based on economic status because it unjustifiably imposes a greater burden on risky clients than on low-risk clients. Additionally, the Article demonstrates that this risk premium cannot be a mere compensation that a risky borrower must pay for the lender’s increased risk. Under this interpretation, adjusting the interest rate and the risk premium after the full payment of the principal is legally required because it prevents discrimination by securing the equal treatment of all borrowers once they have paid the principal. This argument is based on contract law, international human rights law, and international financial regulations. Furthermore, this approach would free resources in the current dramatic Covid-19 context where fiscal space and household incomes must be devoted to save lives and ensure that basic economic and social rights are realized.