“Empowering Borrowers: is the APR the Most Appropriate Choice Indicator? A Behavioral and Empirical Analysis

The ability of consumers to make choices that maximize their wealth and utility is a major concern for policymakers, but it is also fundamental to allowing markets to reach their optimal equilibrium. It is thus an issue of welfare, justice, democracy, and, last but not least, efficiency. However, in many cases (and credit markets certainly apply) the consumer toolbox proves inadequate. Finance is indeed complicated, and the general public lacks the necessary skills to make appropriate choices. To overcome this problem, legislation in this field has tried to empower consumers, making some relevant information more evident, usable, and available. In the case of consumer credit, making the Apr mandatory in pre-contractual and contractual information was, and still is, the golden rule. Criticism of this approach is increasing, however; consumers continuously make choices that are far from optimal, as few are able to pick the cheaper and most appropriate loan. An alternative approach is to gently force consumers in the right direction: this is the perspective of so-called libertarian paternalism, which takes into consideration consumers’ cognitive biases and limitations. In our study we found evidence that the Apr does not drive the decision-making process of potential borrowers; other criteria are normally used, thus leading to suboptimal choices. The behavioral approach to finance has thus proved indispensable; laws and regulations that are applied in everyday life cannot be based on conceptual abstractions which fit in theoretical models but not in our tangible experience. Second, the aristocratic approach to consumer protection must be abandoned: rules for experts cannot solve the problems of common people. Equally aristocratic and inappropriate would be to substitute those rules with the experts themselves, empowering them to decide instead of common people, thus depriving the latter of the freedom to choose. Instead, we propose a gradual and democratic approach based on significant empirical testing; in our case this would mean focusing on those criteria that are really used in the majority of cases to make borrowing choices. Trying the effectiveness of a rule, its real impact on reality, the capacity of those who should comply and/or benefit from it to understand and apply it, seems to us a realistic and efficient approach to policymaking and consumer protection.