Consumer Lending and Borrowing

1. 23 Consumer Lending and Borrowing C h a p t e r Money and Capital Markets Financial Institutions and Instruments in a Global Marketplace Eighth Edition Peter S. Rose McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu

2.  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. • To explore the characteristics of consumer lending institutions. • To understand the rights that consumers have with respect to financial services.

3. Consumers as Lenders of Funds • Consumers 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.

4. 23 - 4 Financial Assets Purchased by Consumers Source: Board of Governors of the Federal Reserve System

5. The Growing Menu of Savings Instruments Available to Consumers Today • One 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.

6. The Growing Menu of Savings Instruments Available to Consumers Today • Examples: • NOW accounts / share drafts • automatic transfer services (ATS) • share accounts at money market mutual funds • consumer cash management services • universal life insurance • individual and Keogh Plan retirement accounts • Roth and Education IRAs • money market and market-index CDs • variable-rate annuities and insurance plans

7. Source: Board of Governors of the Federal Reserve System Consumers as Borrowers of Funds

8. Households and Nonprofit Organizations Amounts outstanding at year-end ($ billions) 1970 1980 1990 2000 2001 Total financial 2,572.3 6,643.0 14,853.9 33,679.9 32,097.5 assets Total debts 478.7 1,455.5 3,746.8 7,507.1 8,083.1 (liabilities) Difference: 2,093.6 5,187.5 11,107.1 26,172.8 24,014.4 assets -liabilities Ratio of 18.6% 21.9% 25.2% 22.3% 25.2% liabilities to assets Data Source: Board of Governors of the Federal Reserve System Is Consumer Borrowing Excessive?

9. Categories of Consumer Borrowing • Financial analysts frequently divide the credit extended to consumers into three broad categories. • Residential mortgage credit – used to support the purchase of homes • Installment credit – used primarily for long-term nonresidential purposes • Noninstallment credit – used for short-term cash needs

10. Home Equity Loans • Like 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.

11. Credit and Debit Cards • A 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.

12. The Determinants of Consumer Borrowing • The consumer’s decision about when and how much to borrow is influenced by: • the size of the individual or family income and accumulated household wealth • the stage in life • the business cycle • price expectations • interest rates

13. Consumer Lending Institutions • Financial 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.

14. Source: Board of Governors of the Federal Reserve System Consumer Lending Institutions

15. Consumer Lending Institutions • Commercial banks approach the consumer • by 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.

16. Consumer Lending Institutions • Savings and loans and savings banks have long been dominant in residential mortgage lending, though they are also aggressively expanding their portfolios. • “Check cashing” companies, “title loan” companies, and “pawn shops” lend primarily to distressed borrowers.

17. Factors Considered in Making Consumer Loans • Consumer loans usually carry greater risk than most other kinds of loans, although they also tend to be more profitable. • Hence, most loan officers carefully consider • the ratio of household debt to gross income • the duration of employment of the borrower • the past payment record (credit integrity) • ownership of valuable properties • the number of breadwinners in the family

18. Financial Disclosure and Consumer Credit • Important 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)

19. Financial Disclosure and Consumer Credit • Competitive 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)

20. Credit Discrimination Laws • The 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)

21. Consumer Bankruptcy Laws • The 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.

22. Consumer Bankruptcy Laws • Consumers 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.

23. Consumer Bankruptcy Laws • In 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.

24. Money and Capital Markets in Cyberspace • Learn more about the various aspects of consumer lending and borrowing by visiting: • http://www.clev.frb.org/research/ • http://www.economagic.com/ • http://www.federalreserve.gov • http://webster.state.nh.us/nhdoj/ • http://www.brook.edu/dybdocroot/ • http://www.bea.gov/

25. Chapter Review • Consumers as Lenders of Funds • Financial Assets Purchased by Consumers • The Growing Menu of Savings Instruments Available to Consumers Today • Consumers as Borrowers of Funds • Is Consumer Borrowing Excessive? • Categories of Consumer Borrowing • Home Equity Loans

26. Chapter Review • Credit and Debit Cards • The Determinants of Consumer Borrowing • Consumer Lending Institutions • Commercial Banks • Finance Companies • Other Consumer Lending Institutions • Factors Considered in Making Consumer Loans

27. Chapter Review • Financial Disclosure and Consumer Credit • Credit Discrimination Laws • Consumer Bankruptcy Laws