Lecture Money and capital markets: Chapter 21 – Peter S. Rose, Milton H.Marquis.ppt (Money Markets)

Chapter 21 Consumer Lending and Borrowing 21 - 3  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 and the laws that protect their rights. • To explore the characteristics of consumer lending institutions. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 4 Introduction • Many financial analysts have referred to the period since World War II as the age of consumer finance. - Individuals and families have become the principal source of loanable funds flowing into the financial markets today. - They also are one of the largest borrowing groups in the entire financial system. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 5 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. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 6 Financial Assets Purchased by Consumers McGraw-Hill/Irwin Money 21 - 6 and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 7 Financial Assets Purchased by Consumers McGraw-Hill/Irwin Money 21 - 7 and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 8 Recent Innovations in Consumer Savings Instruments • 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. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 9 Recent Innovations in Consumer Savings Instruments • 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 McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 10 Consumers as Borrowers of Funds McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 11 Consumers as Borrowers of Funds McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 12 Is Consumer Borrowing Excessive? McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 13 Is Consumer Borrowing Excessive? • The concept of a household portfolio effect argues that consumers may alter their level of spending until they once again feel comfortable with the balance between their income, financial assets, and liabilities. • On the other hand, the wealth effect causes many individuals and families to feel comfortable with heavier debt loads, believing they could sell off their higher-valued assets if trouble appeared on the horizon. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 14 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  McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 15 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. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 16 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. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 17 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 McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 18 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. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 19 Consumer Lending Institutions Leading Consumer Lending Institutions in the United States Source: Board of Governors of the Federal Reserve System. *2004 figures are as of first quarter. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 20 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. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 21 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. • The so-called “fringe banks” (such as “check-cashing” companies, “title loan” companies, “payday lenders,” “pawn shops,” and “rent to own” shops) lend primarily to distressed borrowers. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 22 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 McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 23 Credit Scoring Techniques • Today, credit scoring techniques are used for a wide variety of loans and other financial services. - Advanced statistical techniques are employed to assemble information about applicants for consumer loans, analyze the information gathered, and develop a numerical score. - Using that score, lenders can make a decision as to whether a borrower has scored high enough to qualify for a loan. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 24 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) Lending) (Truth in - Fair Credit Reporting Act (1970) - Fair Credit Billing Act (1974) - Consumer Leasing Act (1976) McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 25 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) • The Financial Services Modernization Act was passed, in part, to create tougher laws to deal with identity theft. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 26 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) McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 27 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. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 28 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. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 29 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. McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 30 Markets on the Net • • • • • Consumer Information Center at www.consumer.gov Equifax Credit Bureau at www.equifax.com Experian Credit Bureau at www.experian.com Federal Deposit Insurance Corporation at www.fdic.gov Federal Reserve Board at www.federalreserve.gov McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 31 Markets on the Net • Federal Trade Commission at www.ftc.gov • FICO Scores and Reports at www.myfico.com • Identity Theft Clearinghouse at rn.ftc.gov/dod/widtpubl$.startup?Z -ORG-CODE=PU03 • National Endowment for Financial Education at www.nefe.org • Transunion Credit Bureau at www.transunion.com McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 32 Chapter Review • Introduction to Consumer Lending and Borrowing • Consumers as Lenders of Funds - Financial Assets Purchased by Consumers - Recent Innovations in Consumer Savings Instruments • Consumers as Borrowers of Funds - Is Consumer Borrowing Excessive? - Categories of Consumer Borrowing McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 33 Chapter Review • • • • Home Equity Loans Credit and Debit Cards The Determinants of Consumer Borrowing Consumer Lending Institutions - Commercial Banks - Finance Companies - Other Consumer Lending Institutions McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 21 - 34 Chapter Review • • • • • Factors Considered in Making Consumer Loans Credit Scoring Techniques Financial Disclosure and Consumer Credit Credit Discrimination Laws Consumer Bankruptcy Laws McGraw-Hill/Irwin Money and Capital Markets, 9/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.

Lecture Money and capital markets: Chapter 21 – Peter S. Rose, Milton H.Marquis

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