Tài chính doanh nghiệp - Chapter 21: Consumer lending and borrowing

Chapter 21Consumer Lending and Borrowing Learning Objectives To see the vital role played by consumers in supplying loanable funds through savings to the money and capital markets.To learn about the important role consumers play as major borrowers of funds and the laws that protect their rights.To explore the characteristics of consumer lending institutions.IntroductionMany financial analysts have referred to the period since World War II as the age of consumer finance. Individuals and families have become the principal source of loanable funds flowing into the financial markets today. They also are one of the largest borrowing groups in the entire financial system.Consumers as Lenders of FundsConsumers as a group are among the most important lenders of funds in the economy.Loanable funds are supplied by consumers – individuals and families (households) – when they purchase financial assets from other units in the economy.Financial Assets Purchased by Consumers21 - 6Financial Assets Purchased by Consumers21 - 7Recent Innovations inConsumer Savings InstrumentsOne of the most important trends affecting consumer savings and lending today is the explosion of new financial instruments.Many of these new instruments offer the consumer greater financial flexibility, as well as the potential for higher rates of return.Recent Innovations inConsumer Savings InstrumentsExamples:NOW accounts / share draftsautomatic transfer services (ATS)share accounts at money market mutual fundsconsumer cash management servicesuniversal life insuranceindividual and Keogh Plan retirement accountsRoth and Education IRAsmoney market and market-index CDsvariable-rate annuities and insurance plansConsumers as Borrowers of FundsConsumers as Borrowers of FundsIs Consumer Borrowing Excessive?Is Consumer Borrowing Excessive?The concept of a household portfolio effect argues that consumers may alter their level of spending until they once again feel comfortable with the balance between their income, financial assets, and liabilities.On the other hand, the wealth effect causes many individuals and families to feel comfortable with heavier debt loads, believing they could sell off their higher-valued assets if trouble appeared on the horizon.Categories of Consumer BorrowingFinancial analysts frequently divide the credit extended to consumers into three broad categories.Residential mortgage credit – used to support the purchase of homesInstallment credit – used primarily for long-term nonresidential purposesNoninstallment credit – used for short-term cash needsHome Equity LoansLike traditional home mortgages, a home equity loan is secured by a borrower’s home.Unlike traditional home mortgages however, many home equity loans consist of a revolving credit line that the borrower can draw on for purchases of any goods or services.Credit and Debit CardsA credit card permits the consumer to buy now and pay later, while a debit card provides a convenient way of paying now.Convenience users substitute credit cards for cash, while installment users maintain large outstanding credit card balances.A smart card is closely related to the debit card.The Determinants of Consumer BorrowingThe consumer’s decision about when and how much to borrow is influenced by:the size of the individual or family income and accumulated household wealththe stage in lifethe business cycleprice expectationsinterest ratesConsumer Lending InstitutionsFinancial intermediaries – banks, savings and loan associations, credit unions, and finance companies – account for most of the loans made to consumers in the U.S. economy.However, a growing share of consumer loans are being sold off the balance sheets and placed in loan pools (securitization).In recent years, institutions also tend to diversify their lending operations.Consumer Lending InstitutionsLeading Consumer Lending Institutions in the United StatesSource: Board of Governors of the Federal Reserve System.*2004 figures are as of first quarter.Consumer Lending InstitutionsCommercial banks approach the consumerby direct lending,through purchases of installment paper from merchants, and by making loans to other consumer lending institutions.Finance companies have a long history of active lending in the consumer installment field, both directly and indirectly.Consumer Lending InstitutionsSavings and loans and savings banks have long been dominant in residential mortgage lending, though they are also aggressively expanding their portfolios.The so-called “fringe banks” (such as “check-cashing” companies, “title loan” companies, “payday lenders,” “pawn shops,” and “rent to own” shops) lend primarily to distressed borrowers.Factors Considered in Making Consumer LoansConsumer loans usually carry greater risk than most other kinds of loans, although they also tend to be more profitable.Hence, most loan officers carefully considerthe ratio of household debt to gross incomethe duration of employment of the borrowerthe past payment record (credit integrity)ownership of valuable propertiesthe number of breadwinners in the familyCredit Scoring TechniquesToday, credit scoring techniques are used for a wide variety of loans and other financial services.Advanced statistical techniques are employed to assemble information about applicants for consumer loans, analyze the information gathered, and develop a numerical score. Using that score, lenders can make a decision as to whether a borrower has scored high enough to qualify for a loan.Financial Disclosure and Consumer CreditImportant new laws have been designed in recent years to protect consumers in their dealings with lending institutions, especially with respect to financial disclosure.Consumer Credit Protection Act (1968) (Truth in Lending)Fair Credit Reporting Act (1970)Fair Credit Billing Act (1974)Consumer Leasing Act (1976)Financial Disclosure and Consumer CreditCompetitive Banking Equality Act (1987)Fair Credit and Charge Card Disclosure Act (1988)Truth in Savings Act (1991)Financial Services Modernization (Gramm-Leach-Bliley) Act (1999)The Financial Services Modernization Act was passed, in part, to create tougher laws to deal with identity theft.Credit Discrimination LawsThe civil rights movement has had an impact on the granting of consumer loans.Equal Credit Opportunity Act (1974, amended 1976)Fair Housing Act (1968)Home Mortgage Disclosure Act (1975)Community Reinvestment Act (1977)Financial Institutions Reform, Recovery, and Enforcement Act (1989)Consumer Bankruptcy LawsThe right to declare bankruptcy is designed to give individuals and businesses a fresh start, helping them to work themselves out from under a crippling burden of debt.Consumer Bankruptcy LawsConsumers filing for bankruptcy primarily use one of two methods.Filing for bankruptcy under Chapter 7 normally completely discharges all of a household’s unsecured debts.A Chapter 13 bankruptcy filing usually sets in motion a new debt repayment plan to work gradually out of the debts owed.Consumer Bankruptcy LawsIn view of the soaring number of bankruptcy filings and in an effort to lower the cost of consumer credit for most borrowers, proposals have been made to make bankruptcy a more costly process and to encourage the development of more financial education courses for consumers. Markets on the NetConsumer Information Center at www.consumer.govEquifax Credit Bureau at www.equifax.comExperian Credit Bureau at www.experian.comFederal Deposit Insurance Corporation at www.fdic.govFederal Reserve Board at www.federalreserve.govMarkets on the NetFederal Trade Commission at www.ftc.govFICO Scores and Reports at www.myfico.comIdentity Theft Clearinghouse at rn.ftc.gov/dod/widtpubl$.startup?Z-ORG-CODE=PU03National Endowment for Financial Education at www.nefe.orgTransunion Credit Bureau at www.transunion.comChapter ReviewIntroduction to Consumer Lending and BorrowingConsumers as Lenders of FundsFinancial Assets Purchased by ConsumersRecent Innovations in Consumer Savings InstrumentsConsumers as Borrowers of FundsIs Consumer Borrowing Excessive?Categories of Consumer BorrowingChapter ReviewHome Equity LoansCredit and Debit CardsThe Determinants of Consumer BorrowingConsumer Lending InstitutionsCommercial BanksFinance CompaniesOther Consumer Lending InstitutionsChapter ReviewFactors Considered in Making Consumer LoansCredit Scoring TechniquesFinancial Disclosure and Consumer CreditCredit Discrimination LawsConsumer Bankruptcy Laws