The financial services industry can be an intimidating web of abstract concepts tied together by strings of complex numerical calculations. Fortunately, the average consumer isn’t required to interact with highly complex financial assets on a regular basis, or even ever. Since the global financial crisis, the world has come to focus on the dealings of investment banks, the assets that they deal in, and the risks that they take on. However, this focus is blind to many of the practices that have defined the consumer finance industry. In recent years, many have noted rising household debt levels, even as median incomes rise across the U.S. and Canada. Perhaps this is, in part, due to the increasing intricacy of consumer finance products.
In the wake of the 2008 global financial crisis, accountability standards demanded of financial institutions were ratcheted up. This demand for oversight led to the inception of the Consumer Financial Protection Bureau, which furnishes a database of complaints about consumer-facing financial products. Over this period, about 740,000 complaints were registered. However, of these, only about 8,079 were classified as concerning interest rates. This represents just about 1%. A similar number was reported for issues resulting from unexpected or exorbitant fees charged by the financial institution. However, over 34,000 complaints concerned false or misleading communication with either existing customers or through false advertising of products. This constituted 5% of all complaints received since January 2012.
The reason that consumers aren’t complaining about interest rates may be in the fact that there simply aren’t competitive interest rates provided in the consumer financial products market. We discuss below the impact of non-competitive interest rates for consumers in borrowing, but here we look at the impact it has on returns for the average consumer as a lender. The most common form of investment asset that Canadians hold is the consumer savings account. Though many people use this more as a utility than an investment, it is a financial holding that provides a certain level of return over time. These are contrasted with checking accounts, which typically offer no interest on deposits. Of the major Canadian financial institutions, all offer the same interest rate on their clients’ accounts: 0.5%. Compare this to the interest rate offered by a small bank like Alterna, which provides a 1.95% interest rate on personal savings accounts. (Alterna Bank, 2017) Evidently a so-called “high-interest” account at the major Canadian financial institutions is not necessarily the best deal for consumers. However, there is an anchoring effect in stating this interest rate as being “high”, especially when the largest Canadian financial institutions offer the same rate.
The effect of this can be studied with respect to Herbert Simon’s seminal research into how individuals make decisions. Individual people are forced to frame the question with respect to what they know based on past experiences. If key alternatives (like small bank offerings) are not presented to the consumer, then the only rational decision in their mind is to choose between those 4 or 5 banks that offer the same interest rate. This constitutes a limit on their potential for making rational decisions, thus “bounded rationality”. To different consumers, these boundaries are different, but based on prevailing market conditions, it is apparent that the average consumer’s ability to make the decision that matches that of the ideal “economic man” is heavily impaired.
By no means do I propose that the misunderstanding of what constitutes a high interest rate is at the root of growing household debt. However, a broader understanding of consumer finance products, including what interest rates represent, (and what constitutes a high one) could help to empower consumers to make wiser decisions regarding their financial standing.
Alterna Bank. (2017, April 6). High Interest eSavings Account. Retrieved from Alterna Bank Web site: https://www.alternabank.ca/Personal/EverydayBanking/Accounts/eSavings/
Consumer Financial Protection Bureau. (2017, March 27). Consumer Complaint Database. Retrieved from Consumer Financial Protection Bureau Web site: https://www.consumerfinance.gov/data-research/consumer-complaints/
Simon, H. (1957). A Behavioral Model of Rational Choice. In Models of Man. New York: John Wiley and Sons.
The Toronto-Dominion Bank. (2017, March 10). Account Interest Rates. Retrieved from TD Canada Trust: https://www.tdcanadatrust.com/products-services/banking/accounts/account-rates.jsp
Picture titled, "August 2012 Bay and King Bank Towers Toronto Looking Up", taken by Goerge Socka on August 1, 2012, obtained through Creative Commons (https://flic.kr/p/cHZn1C)