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Price Regulation in Credit Markets: A Trade-off between Consumer Protection and Credit Access

SIEPR
Sep 2021
Working Paper
21-047
By  Jose Ignacio Cuesta, Alberto Sepulveda

Interest rate caps are widespread in consumer credit markets, yet there is limited evidence on their effects on market outcomes and welfare. The effects of this policy are ambiguous and depend on a trade-off between consumer protection from bank market power and reductions in credit access. We exploit a policy change in Chile that lowered interest rate caps by 20 percentage points to understand its impacts. Using individual-level administrative data, we find that the policy decreased contract interest rates by 9%, but also reduced the number of loans by 19%. To assess welfare and counterfactuals, we develop and estimate a model of loan applications, pricing, and repayment. Consumer surplus decreases by an equivalent of 2.5% of average income, with larger losses for riskier borrowers. However, the same policy in a less competitive market increases welfare. Risk-based regulation reduces the adverse effects of interest rate caps, but does not eliminate them.

Publication Keywords: 
credit
loans
interest rate caps
regulation
Selection
Competition