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Price Regulation in Credit Markets

Summary:
From Cuesta and Sepulveda’s Price Regulation in Credit Markets: A Trade-off between Consumer Protection and Credit Access. Interest rate caps are widespread in consumer credit markets, yet there is limited evidence on its effects on market outcomes and welfare. Conceptually, the effects of interest rate caps are ambiguous and depend on a trade-off between consumer protection from banks’ market power and reductions in credit access. We exploit a policy in Chile that lowered interest rate caps by 20 percentage points to understand its impacts. Using comprehensive individual-level administrative data, we document that the policy decreased transacted interest rates by 9%, but also reduced the number of loans by 19%. To estimate the welfare effects of this policy, we develop and estimate a

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From Cuesta and Sepulveda’s Price Regulation in Credit Markets: A Trade-off between Consumer Protection and Credit Access.

Interest rate caps are widespread in consumer credit markets, yet there is limited evidence on its effects on market outcomes and welfare. Conceptually, the effects of
interest rate caps are ambiguous and depend on a trade-off between consumer protection from banks’ market power and reductions in credit access. We exploit a policy in Chile that lowered interest rate caps by 20 percentage points to understand its impacts. Using comprehensive individual-level administrative data, we document that the policy decreased transacted interest rates by 9%, but also reduced the number of loans by 19%. To estimate the welfare effects of this policy, we develop and estimate a model of loan applications, pricing, and repayment of loans. Consumer surplus decreases by an equivalent of 3.5% of average income, with larger losses for risky borrowers. Survey evidence suggests these welfare effects may be driven by decreased consumption smoothing and increased financial distress. Interest rate caps provide greater consumer protection in more concentrated markets, but welfare effects are negative even under a monopoly. Risk-based regulation reduces the adverse effects of interest rate caps, but does not eliminate them.

Hat tip: Matt Notowidigdo.

The post Price Regulation in Credit Markets appeared first on Marginal REVOLUTION.

Alex Tabarrok
Alex Tabarrok is Bartley J. Madden Chair in Economics at the Mercatus Center at George Mason University and a professor of economics at George Mason University. He specializes in patent-system reform, the effectiveness of bounty hunters compared to the police, how judicial elections bias judges, and how local poverty rates impact trial decisions by juries. He also examines methods for increasing the supply of human organs for transplant, the regulation of pharmaceuticals by the FDA, and voting systems.

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