The Salience Theory of Consumer Financial Regulation

Abstract

Prior to the financial crisis, banks’ fee income was their fastest-growing source of revenue. This revenue was often generated through nefarious bank practices (e.g., ordering overdraft transactions for maximal fees). The crisis focused popular attention on the extent to which current regulatory tools failed consumers in these markets, and policymakers responded: A new Consumer Financial Protection Bureau was tasked with monitoring consumer finance products, and some of the earliest post-crisis financial reforms sought to lower consumer costs. This Article is the first to empirically evaluate the success of the consumer finance reform agenda by considering three recent price regulations: a decrease in merchant interchange costs, a cap on credit card penalty fees and interest-rate hikes, and a change to the policy default rule that limited banks’ overdraft revenue. The varied efficacies of these interventions suggest several insights for policymakers. First, price regulation of non-salient prices (such as late fees or overdraft charges) is desirable. This is true even in a perfectly competitive world, because the existence of shrouded prices can lead to excessive demand for consumer financial products; cause consumers to expend tremendous energy to avoid hidden fees; and result in cross-subsidy of sophisticated consumers, who incorporate these prices into their decision-making, by unsophisticated customers, who do not. In an imperfectly competitive world, regulations that target non-salient prices can also decrease overall consumer costs. A substitute for price regulation is the use of behavioral tools, such as shocks to consumer attention, to encourage consumers to take non-salient prices into account. Such simple, timely disclosure is a choice-preserving alternative to banning expensive consumer finance products.