Unintended Consequences of the Credit Card Act

57 Pages Posted: 10 Jun 2014 Last revised: 15 Feb 2016

See all articles by Tiago Pinheiro

Tiago Pinheiro

City University London - The Business School

Joshua Ronen

New York University (NYU) - Department of Accounting

Date Written: September 2015


This paper asks first why consumers seek financing through credit cards. It then evaluates the impact on consumer welfare of the constraints on increasing interest rates present in the Credit Card Act. We model consumer financing in a setting where consumers do not commit to borrow from a given lender and where information asymmetry between a consumer and a lender arises over time. The existence of ex-post information asymmetry coupled with the lack of commitment leads to adverse selection of consumers which, in turn, prompts lenders to offer credit terms that are inefficient relative to a setting with perfect information. This inefficiency is alleviated if credit contracts have some of the features that we observe in credit cards, and we show that these features arise in the competitive equilibrium credit contract. Specifically, in a competitive equilibrium the issuer charges an up-front fee and commits to an interest rate before a loan is taken; the issuer retains an option to change the interest rate upon new information, and consumers have an option to repay the loan at any time. We also show that restrictions on increasing the interest rate, as in the Credit Card Act, are welfare decreasing. They lead to lower up-front fees, higher credit card interest rates for low credit-quality consumers, and lower credit limit for high credit-quality consumers. This paper contributes to the literature by providing a new model of credit cards, and offers predictions of relevance for policy makers.

Keywords: Consumer Financing, Credit Card Act, Welfare

Suggested Citation

Pinheiro, Tiago and Ronen, Joshua, Unintended Consequences of the Credit Card Act (September 2015). Journal of Law, Finance & Accounting, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2448067 or http://dx.doi.org/10.2139/ssrn.2448067

Tiago Pinheiro

City University London - The Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Joshua Ronen (Contact Author)

New York University (NYU) - Department of Accounting ( email )

40 West 4th Street, Suite 400
Suite 10-180
New York, NY 10012-1118
United States
212-998-4144 (Phone)
212-995-4599 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~jronen/

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