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Measuring the Welfare Cost of Asymmetric Information in Consumer Credit Markets

Journal: Journal of Financial Economics

Date: 20221201

Author: DeFusco, Anthony A.; Tang, Huan; Yannelis, Constantine

Abstract:
Information asymmetries are known in theory to lead to inefficiently low credit provision, yet empirical estimates of the resulting welfare losses are scarce. This paper leverages a randomized experiment conducted by a large fintech lender to estimate welfare losses arising from asymmetric information in the market for online consumer credit. Building on methods from the insurance literature, we show how exogenous variation in interest rates can be used to estimate borrower demand and lender cost curves and recover implied welfare losses. While asymmetric information generates large equilibrium price distortions, we find only small overall welfare losses, particularly for high-credit-score borrowers.

Link: Google Scholar

Background and Context

Market Setting

This study examines the Chinese fintech consumer lending market, which at its peak in 2017 exceeded $210 billion in loan volume and represented over half of global fintech lending.

Research Approach

The study analyzes a randomized experiment conducted by a major Chinese lending platform in 2018 involving 11,000 loan applicants who were offered different interest rates.

Methodology

The researchers examined how borrower demand and lender costs vary with interest rates to measure welfare losses from asymmetric information in online consumer credit markets.

Higher Interest Rates Significantly Reduce Loan Take-up

  • The experimental low-price group had a 65% take-up rate compared to 58% in the high-price group
  • A 14.5 percentage point increase in interest rates led to a 7 percentage point decrease in take-up
  • This demonstrates that borrower demand is sensitive to interest rates

Higher Interest Rates Lead to Higher Default Rates

  • High-price group borrowers had a 13% charge-off rate versus 11% in the low-price group
  • This indicates presence of asymmetric information - riskier borrowers select into higher interest rate loans
  • A 10 percentage point increase in interest rates raises charge-offs by 1 percentage point

Large Price Distortion but Small Quantity Effect

  • The equilibrium interest rate (30%) is much higher than the efficient rate (9%)
  • Despite this large price distortion, the quantity effect is small due to inelastic demand
  • Only 10 percentage point reduction in take-up between equilibrium and efficient prices

Welfare Losses are Larger for Lower Credit Score Borrowers

  • Welfare losses for low credit score borrowers (¥1.79 per ¥100) are about 7 times larger than for high credit score borrowers (¥0.26 per ¥100)
  • This suggests asymmetric information problems are more severe for observably riskier borrowers
  • However, even for high-risk borrowers, the absolute welfare losses remain small

Small Overall Welfare Losses from Asymmetric Information

  • The average welfare loss is only ¥50 ($7.20) per loan application
  • This represents just 0.8% of the typical loan amount
  • Small welfare losses suggest limited benefits from policy interventions targeting asymmetric information

Contribution and Implications

  • First study to comprehensively measure welfare costs of asymmetric information in fintech lending
  • Demonstrates that while asymmetric information leads to large price distortions, overall welfare losses are small due to inelastic demand
  • Suggests limited economic justification for policy interventions like interest rate subsidies or loan guarantees in this market

Data Sources

  • Take-up and charge-off rates from Table 1 and Figure 2
  • Price distortion analysis from Table 2 Panel C
  • Credit score heterogeneity from Table 3
  • Overall welfare loss calculations from Table 2 Panel C