Financial deepening through loan piricing transparency and its impacts

Many consumers in financial markets find out about the characteristics of products exclusively from financial institutions, whose staff arguably have better information about the cost and terms of the loans they offer. However, financial institutions and their staff shroud prices in order to maximize profits. This prevents consumers from making well-informed borrowing decisions. In fact, credit markets are characterized by substantial price dispersion, including in Uganda. While the variation in prices may be driven by riskiness or the transaction costs involved in servicing different customers, identical individuals who are offered a loan of the same size around the same time can face a substantially different total cost of credit. Even facing substantial price dispersion, consumers still engage in little comparison shopping. Hence, the question is whether there is an information constraint that prevents borrowers from choosing the least costly loans. Subsequently, if there is an information constraint, does improving access to comparative information on loan pricing from different lenders in an easy-to-understand format help (prospective) borrowers access more affordable loans?

In this project, the researchers will run an experiment to investigate the role of access to comparative loan information in consumer borrowing decisions (including MSMEs), and how providing easy-to-process comparative information improves decision making. The experiment consists of two parts. First, the researchers will elicit the maximum willingness-to-pay for the comparative loan information among existing (and potentially prospective) borrowers. The willingness-to-pay (conditional on income) can be interpreted as a proxy for how valuable the individual deems the information ex-ante. Second, they will follow actual financial behavior and decisions for the treatment group (individuals who obtained the information) and the control group (those who did not) across time. Since there is random variation in assignment to the comparative information treatment, it will be possiible to evaluate the causal effect of access to the comparative information on borrowing behavior.

This project holds policy relevance at the micro and macro levels. At the micro level, the issue of pricing transparency is an important aspect of financial consumer protection. In low-income countries like Uganda, a large share of the population is self-employed as entrepreneurs and, among formal financial institutions, borrowing for business growth is common. Getting credit on the right terms to entrepreneurs is also crucial for the growth of these firms. Findings on optimization failure and how information can help can likely be extrapolated to other low-income countries too. If the comparative information appears to be effective, then it could be spread among the population (for instance, financial institutions could be compelled to hang this information on their branches). Or the information could be provided when new businesses apply for trading licenses. Information provision is also likely a more cost-effective way to improving borrowing decisions than financial education initiatives. At the macro-level, improved pricing transparency should ultimately lead to lower cost of credit through increased price competition. Increased transparency is likely to be a better policy lever to increase competition in the credit sector, enhance efficiency and bring down interest rates than capping interest rates. Lower lending rates should spur investment, reduce household financial distress, and ultimately boost economic growth and welfare.

Authors

Xavier Gine

World Bank

Joeri Smits

Yale University