Voluntary Minimum Repayments and Borrower Heterogeneity: Evidence from Revolving Consumer Credit

Abstract

Based on a unique dataset provided by a retail bank, we analyze borrower heterogeneity in the debt response to interest rate decreases and credit limit increases in revolving consumer credit. Our key findings show that 1) the debt response to interest rate decreases by borrowers who choose voluntary minimum repayments (VMR) is about four times as large as the response by borrowers not choosing this option, 2) VMR borrowers demand credit limit increases which are more than twice as high as those of non-VMR borrowers following interest rate cuts, and 3) VMR borrowers' marginal propensity to consume out of credit limit increases is almost 30% stronger. These results are most likely to be caused by sophisticated present-biased individuals choosing to commit and shed new light on the role of non-standard borrower preferences in consumer credit.

Keywords: Financial Intermediation, Behavioral Finance, Household Finance, Consumer Credit

JEL Classification: D12, D14, D91, G21