Consumer Credit Regulation the Third Way

1
Consumer Credit Regulation - the
Third Way?

• Australian Credit at the Crossroads Looking for
  Landmarks8 9 November 2004Melbourne
• Keynote Address
• Iain Ramsay, Osgoode Hall Law School, York
  University, Toronto, Canada

2
Reform initiatives

• UK
• EU
• Canada
• South Africa
• Australia
• New Zealand
• CI Asia/Pacific Consumer Credit Project
• US

3
Background to reforms

• Changes in consumer credit consumer lending
  revolution.
• Deregulation, securitization, application of
  sophisticated computer technologycredit scoring,
  spread of all purpose credit cards.
• Consumer credit a driver of the economy.
• Credit used for services once paid for by state
  e.g. education.
• Increasing internationalization of credit
  institutions (credit bureaux) and forms (credit
  cards, sub-prime lending).

4
Contemporary issues

• The role of disclosure in credit transactions
• Over-indebtedness
• Responsible lending
• Regulation of the sub-prime market

5
Existing approaches to regulation of consumer
credit

• Information approach v. social consumer
  protection.
• Autonomy v. paternalism.

6
The Third Way approach to consumer credit
regulation

• Attempt to empower individuals in market
  (information/controls on catastrophic risks).
  Protect Autonomy.
• Recognise importance of achieving affordable and
  accessible credit for all
• Address overindebtedness through a wide variety
  of preventive and regulatory measures
• Regulation as multifaceted, hybrid, influencing
  market interactions rather than merely policing
  infractions.

7
Payday loans as example

• Combination of increasing competition,
  disclosures, regulation, development of
  institutional alternatives
• Competition-reduce switching costs for consumers
  from sub-prime to prime (credit scoring).
  Encourage entry of mainstream lenders.
• Information disclosures.
• Regulation targeted on problem areas (e.g.
  rollovers)
• Interest rate ceilings as a proxy for fraud.
• Targeted enforcement. Need for public agency
  public interest groups.
• Development of institutional alternatives role
  of community reinvestment, credit unions.

8
Behavioural economics and consumer credit
regulation

• Behavioural biases deviating from rationalistic
  assumptions of neo-classical economics.
• Misestimations of risk, overoptimism, inability
  to process more than 5-7 pieces of information.
• Distinction between planner self and impulsive
  self time inconsistent preferences.

9
Behavioural economics and credit cards

• Underestimation and overoptimism
• Structure of credit card pricing overprices long
  term contingencies (need to borrow) underprices
  short term (transaction fees, annual fees).
• Businesses to compete successfully must exploit
  these biases.
• Automatic increases in credit limit results in
  greater borrowing even by consumers who are not
  liquidity constrained.

10
Potential responses

• Targeted disclosures to individuals paying
  minimum payments. Individualize disclosures.
• Default term for cards e.g. no automatic
  increase. Control minimum repayment amounts.
  Consumer must opt in.
• Retains consumer choice.

11
Behavioural economics and payday loans

• Why do individuals pay extremely high interest
  rates for short term loans?
• Some have no choice but others choose.
• Individuals seem willing to pay high discount
  rate to receive small sums of money immediately.
  Hyperbolic discounting.
• Costs of waiting for money processed as foregone
  consumption rather than foregone interest.
• Underestimation and overoptimism result in
  rollovers.

12
Behavioural economics and future of credit
disclosures

• Information overload response Schumer box
  key financial info.
• Exploit loss aversion wealth warnings-but
  target them?.
• Harness availability heuristic but avoid
  disclosures that result in overestimation of
  risk.
• Personalise information individuals are poor
  statisticians. The potential of computer
  technology to target disclosure.
• Post-contractual disclosures.

13
Behavioural economics conclusions

• Utilize to develop debiasing interventions
• Distinction between rational and vulnerable
  consumer?
• Distinction between autonomy and paternalism?
  Regulation to protect future autonomy.
• Limits on disclosures at time of contract in
  preventing overindebtedness.
• Recognise from outset that trouble may occur and
  build in mechanisms of adjustment

14
Impact of technology, credit scoring and credit
bureaux

• Credit scoring and credit bureaux substantially
  reduce credit suppliers information problems.
• Credit scoring and credit bureaux facilitate
  growth of credit cards and sub-prime market.
• Development of risk based and behaviour driven
  pricing.

15
Impact of negative and positive credit bureaux

• Negative claimed to result in greater incentives
  not to default.
• Positive info facilitate a deeper credit
  market facilitate competition.
• Impact on default rate?

16
Credit scoring

• Need for transparency and dialogue on these
  systems.
• Like much technology--- costs and benefits e.g.
  might permit individual to graduate from
  sub-prime to prime.

17
Responsible lending

• Objectives reduce default, control unfair
  practices
• EU Directive check data baseensure suitability
  best advice
• UK reform of extortionate credit credit
  licensing
• US responsible lending bills to combat predatory
  lending
• South Africa concept of reckless credit
• Switzerland detailed rules on checking database
  ensure that proposed loan does not reduce
  individual below minimum living requirements

18
Responsible lending

• Relationship to role of technology and credit
  scoring?
• Need to incorporate standards into everyday
  practices of employees. May need to change
  structure of incentives.

19
Responsible lending and overindebtedness

• What is optimum level of overindebtedness in
  society?
• Establish standardtax or fine if dont meet
  standard.