English Usury Law and its Abolition

Whether usury laws stunted the growth of finance, especially in early modern Europe, is a question that causes much disagreement. The degree of enforcement of these laws may have had some impact on the level of financial development in different parts of Europe but it would be difficult to argue that usury laws stifled all development. Indeed, lenders went to great lengths to develop complex legal workarounds. This helped precipitate the end of such restrictions altogether. In England, the decline and abolition of usury law was caused by this widespread evasion along with changing moral attitudes towards lending.

Usury and the Law

Civilization has not always been friendly to moneylenders. Charging interest on loans has been restricted since the days of Hammurabi over 3750 years ago. Under more modern Catholic canon law, usury was defined as lending money at any rate of interest at all; the strictest believed it was evil in and of itself and they gave little consideration to the exact intentions of the parties involved. If they were found to have made a usurious loan, a lender in England would not simply have had his loan voided but a penalty of three times the principal and interest would be levied.

Quentin Matsys’s ‘The Moneylender and his Wife’ (1514)

Of course, lending was too mutually beneficial to be left to charitable motivations alone, so early financial engineers contrived ways to work around the canon law. Lenders obscured their transactions to make it seem that no interest was being charged on a loan when of course there really was. Ecclesiastical courts, attempting to enforce usury laws, often found it very difficult to distinguish usurious dealings from permitted ones based on the substance of the deal alone.

By the early modern period, lending was increasingly permitted and perhaps even encouraged. The prohibition of usury, under its strict definition of charging any interest at all, was removed in England in 1545. This act by the excommunicated King Henry VIII was reversed after his death but the prohibition on interest was finally abolished for good in 1571.

People had come to regard usury as the charging of excessive interest rather than interest itself and the exact intent of the parties began to matter more to the formation of people’s moral judgment. After all, it seemed especially strange in a commercial setting, where both parties gained from a loan, that one party, the lender, should see no benefit and be encouraged to act only out of generosity. This distinction between commercial and non-commercial loans was made legally significant in the Netherlands where Emperor Charles V permitted lending at up to 12% interest but only on commercial loans.

Upon the legalization of lending at interest, a maximum rate was set at 10% in England but from here the laws tightened once again. The maximum legal interest rate fell over the course of the 17th century, being reduced to 8% in 1624 and reaching 6% in 1651. The interest rate ceiling reached its nadir of just 5% in 1714 and here it would remain for over a century. These were very low limits. Indeed, during this period, the rate paid by the government on its own borrowings was often above the maximum legal rate it set. As a result, lenders continued to attempt workarounds and common law courts found it as difficult to separate perfectly legal transactions from usurious loans as had the religious authorities before them.

Workarounds

Lenders were crafty. A common approach was to structure loans as purchases of annuities. After all, repayment of a loan is rather like an annuity. A typical arrangement was one where the lender would purchase an annuity from the borrower; the latter would then pay an annuity of one-sixth of the amount borrowed per year for the rest of their life. Of course, there was a risk that the borrower would die before the principal was returned. To solve for this, the lender could purchase life insurance on the life of the borrower so that even this risk was removed.

Circumventions of usury laws in early modern times frequently made use of insurance. In maritime Italian cities, lenders would finance voyages with the condition that the loan be forgiven if the ship was lost, making the loan look more like an insurance policy and disguising interest as insurance premiums. These loans were known as ‘sea loans’.

Some strategies masked lending as sales of goods at a price above the going market rate. For example, a lender might sell a commonly-traded product to a borrower on credit at a marked-up price. The borrower would then resell the product, albeit at the lower market price, having already bound himself to repay the lender at the higher price. The price differential here was a profit to the lender and masked all or part of the ‘interest’ charged to the borrower.

Other lenders structured loans as sales of things other than physical goods. Some purchased a portion of the borrowers’ future inheritance at a discount. There was also the ancient practice of discounting bills and this served as still another way of concealing interest rates above the legal limit. Here, a lender would purchase a bill or receivable due to the borrower at a discount but would charge no formal ‘interest’ per se.

Borrowers

Perhaps because of the many workarounds, falling interest rate ceilings did not kill off more risk-tolerant lenders. Rather, the use of credit seems to have grown considerably from the late 17th century on, a period known as the ‘Financial Revolution’ in Britain. Agricultural depressions, growing consumerism, vices, and financial crises made borrowing a regular habit for many.

Filling the need for credit weren’t just moneylenders. Shopkeepers were also among the providers of credit to ordinary consumers and this was widely tolerated. However, low interest rate caps may have pushed less creditworthy borrowers towards less appreciated lenders, including pawnbrokers and Jewish lenders operating outside the religious customs governing Christians. However, these lenders were also increasingly left unbothered. Realists recognized the weaker security tied to riskier loans and that their lending allowed poorer households to survive lean times.

Regardless, there is evidence that the lower interest rate caps hurt commoners at the expense of more creditworthy, and thus wealthier, borrowers. Artificially reduced interest rates made it more important than ever to limit losses. This may help explain why the earliest English banks rarely lent to ordinary people and their lending was perhaps further confined to the wealthy as usury restrictions got tighter.

The records of one London bank, Hoare’s, show that the average loan size increased sharply after the maximum legal rate was reduced to 5%, suggesting that smaller borrowers were squeezed out of the formal lending business. The bank reduced its risk by favoring wealthy and well-known borrowers. They also demanded more loans be secured, reversing a previous trend towards more unsecured lending. Supporting the argument that the interest ceiling was set too low for consumer lending, over 90% of the loans made by this conservative bank charged interest at exactly the legal maximum rate.

Repeal

In the late days of the British Enlightenment, even liberal philosophers did not agree on what to think of usury restrictions. Adam Smith supported them while the famous utilitarian Jeremy Bentham was opposed. Smith believed lower rates would restrict the borrowings of spendthrifts and speculators and would limit borrowing to only the sober and honest. Bentham meanwhile believed the restrictions to be a violation of liberties that would only empower loan sharks and disadvantage borrowers.

One can argue they were both mostly right. Indeed, to some extent, Smith and Bentham’s disagreement seems to stem from whether they believed such restrictions could really be enforced. Smith’s argument seems perfectly logical if you believe they could be and Bentham’s sounds more convincing if you believe they couldn’t.

Conventional scholarship suggests the laws usually weren’t well enforced but there is still disagreement on this matter with some arguing that, though they undoubtedly occurred, circumventions of the law were exceptions rather than the rule. In any case, a Parliamentary Select Committee on Usury Laws issued a generally negative report on interest restrictions in 1818, insisting evasion was extensive. This helped pave the way for their repeal and interest rate caps on bills of exchange were lifted in 1833. Usury restrictions were scrapped altogether in Britain in 1854.

“That it is the opinion of this Committee, that the Laws regulating or restraining the rate of Interest have been extensively evaded, and have failed of the effect of imposing a maximum on such rate; and that of late years, from the constant excess of the market rate of interest above the rate limited by law, they have added to the expense incurred by borrowers on real security …”
Select Committee on Usury Laws (1818)

Lesson

Those arguing against usury laws often cited their frequent evasion and potentially negative effects on borrowers. These arguments made the case for usury prohibition increasingly less convincing in the aftermath of Britain’s Financial Revolution. Indeed, rather than stop financial conniving, restrictions on interest encouraged substantial creativity. It was incredible to expect creditors to limit their returns on all lending to a rate of interest often below the government’s own borrowing cost. By the mid-19th century, Britain had seen enough and the centuries’ long project of restricting interest was entirely abandoned.

More from the Tontine Coffee-House

Read about the role evolving moral attitudes towards lending had in fostering religious support for early banking institutions, the monti di pietà. Even lenders in the Church’s backyard circumvented usury restrictions, including the Knights Templar and the Medici banking family. Also consider subscribing to this blog’s newsletter here.

Comments (1)

Allan Jones
January 23, 2023
Thank you for this piece, perhaps the repeal of interest is one thing, but in today’s world the “workarounds” have transformed in to all sorts of “leverages” like derivatives. No doubt also, within the laws of the day, but the main flaw now, that has expanded leverage is the “creation of credit”. This is a previously non existent credit by a bank made available only upon the ability of a borrower to show means of repayment. This means that the realization that a bank “creates credit out of nothing” is wrong for it is the borrower that gives life to the money we use today, originating as “created credit”, which then becomes debt, It seems therefore, that a world wide 100% “workaround” has taken place caused by the same human trait of greed that distorted a fixed usury, & is now circumventing the meaning of money itself.