Standardization, disclosure, and consumer loan outcomes

Figure 1: Example of a standardized loan contract (there is no fine print, but lenders can charge different interest rates) and a disclosure contract where there is fine print, but important features are made salient (e.g., highlighted in blue text at the beginning of the contract in this example).

We posit that if a borrower is surprised by unexpected fees after signing a contract, the borrower is more likely to default on the monthly payments. If the borrower is aware of the total monthly cost, they can choose not to take out a loan, take out a loan with a better ability to budget for monthly costs, or search for a loan from a less expensive provider. We believe that both policy strategies can help borrowers avoid default, but they may be more effective for different borrowers. In particular, borrowers with high “costs” of studying will benefit from standardized contracts. These contracts can reduce unexpected fees without the borrower having to review carefully or even understand complex financial terminology. In contrast, disclosure regulations make salient important elements of the financial contract, which help borrowers who are already fairly financially sophisticated (“low study cost”). Those borrowers may not want to read the fine print, but they would understand it if they did.

Chile introduced two regulatory changes that allow us to examine the effects of standardized contracts and disclosure. In 2011, it introduced a contract called “Universal Credit” contracts that was both standardized and had improved disclosure. These contracts had to be shown to everyone who took out a loan below a certain cutoff amount, but the prospective borrower could choose a loan that was not a Universal Credit contract. In 2012, due to the popularity of the disclosure features of the Universal Credit contracts, they were subsequently applied to all loans. We exploit the different timing of the regulations to tease apart the effects of standardized contracts and disclosure separately.

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To estimate the effects of the different regulations, we compare borrowers just above and below the regulatory loan cutoff. In Chile, consumer loans and transactions are conducted in one currencyChilean pesos—while the regulation applies at a cutoff in a second, inflation-adjusted currency—Unidad de Fomentos (UF). As consumers are likely to target their loan amount in pesos, they are unlikely to manipulate their loan amount in UF to be above or below the cutoff based on the daily exchange rate between the two currencies. Because of this dual-currency system, prospective borrowers near the cutoff would be randomly assigned to seeing Universal Credit contracts when they took out a loan, and borrowers above the cutoff would not be provided the contracts as a loan option.

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