Risk-Based Borrowing Limits in Credit Card Markets
41 Pages Posted: 3 Sep 2024
Date Written: August 15, 2024
Abstract
I use novel statement-level data on the 2010-2015 UK credit card market to show that lenders primarily individualize contracts through risk-based credit limits. Though shared with other European credit markets, this feature contrasts with the US counterpart, where interest rates are also individualized. To quantify the welfare implications of this distinction, I estimate a structural model that explains credit limit distributions with lender-specific credit scores. I evaluate a counterfactual where lenders can freely individualize prices and credit limits, which the existing environment precludes. Lenders control default risk with credit limits and use prices to extract surplus from inelastic borrowers.
Keywords: Risk-based credit limits, risk-based pricing, adverse selection, credit cards
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