The effect of cognitive debiasing and APR on consumer loan demand

Abstract

Credit defaults and the amount of new credit marks reached their peak in 2015 in Finland. The increased availability of instant consumer loans is seen as one of the key explanation for over-indebtedness and insolvency problems, especially amongst young adults and people with poor financial literacy. The regulator has thus introduced and updated existing legislations to better cope with the reformed consumer credit market. Arguably the two most significant legislative interventions were the Ministry of Justice's act in December 1st 2010 to standardize and mandate disclosure of loan borrowing costs in form of annual percentage rate (APR), followed later by the change in the Consumer Protection Law that took effect in June 1st 2015 to set an APR cap of 50 percent added by the market rate effective to all loan amounts below €2,000. The objective of this study is to empirically assess the effectiveness and consequences of these regulatory interventions to consumer behavior.

The data of this study is provided by one of the leading instant consumer loan providers in Finland. More specifically, four panel datasets are collected from the application data of two distinct instant consumer loan products. Application volumes are then used to measure statistically significant variation in aggregate loan demand in two events surrounding the legislative induced changes in the credit market. The analysis is then continued by assessing potential changes in the consumer demography after these events using a logistic regression model.

Based on the empirical findings, no evidence is found about additional information disclosure's effectiveness in cognitively debiasing instant loan consumers and consequently lowering their aggregate loan demand. Furthermore, high rate consumer loan demand on aggregate is found to be insensitive with changes in APR implied borrowing costs. The legislative interventions were not found to have affected the borrowing behavior of financially unsophisticated or young adults. Instead, the relative amount of financially constrained borrowers increased after both of the legislative interventions. The instant loan industry was observed to having quickly adapted to the new legal environment by introducing products with bigger loan amounts and maturities, which are not restricted by the new law.