Credit limit extensions significantly increase consumer expectations about future income growth. After controlling for the changes in consumer income expectations, the spending responses to credit limit extensions decrease by around 34%. In addition, credit extension on average induces over-optimism about future income changes, as well as a higher default rate.
Investing in Lending Technology: IT Spending in Banking
with Zhiguo He, Sheila Jiang, and Douglas Xu, 01/2024
Link banks' IT spending in various categories to different lending technologies. Investment in communication IT is associated more with improving banks' ability of soft information production and transmission, while investment in software IT helps enhance banks' hard information processing capacity.
Microfounding Household Debt Cycles with Extrapolative Expectations
with Francesco D'Acunto and Michael Weber, 02/2024
After unexpected positive income shocks, consumers form excessively positive expectations about future income and debt capacity relative to the ex-post realizations. They also raise debt to finance higher current spending. This subsequently increases their likelihoods of default in the medium run. The effects are larger for lower-income consumers and consumers who face more volatile income streams.
Banks that receive a large amount of firm hard information get better screening ability and make loans with lower default rates, and higher interest rates. This increases the profitability of the banks but has an insignificant impact on total lending volume. The effects are larger for banks with higher IT capacity. Consequently, high IT-capacity banks cream-skim high-quality borrowers from low IT-capacity banks.
Consumers have noisy perceptions of the interest costs of credit cards. Debt-takers on average underestimate the APR by around 4.5 percentage points. Negative perception errors in interest rates induce more borrowing, while positive perception errors do not affect borrowing. An information treatment about the true interest costs of credit card debt brings the negative perception bias back to the true level and reduces credit card debt. However, borrower perception bias and debt revert by more than 50% after six months of the treatment.