Behavioral economics and RBI’s move to ban zero financing on consumer durables…

RBI recently banned banks from offering 0% EMIs on consumer durable products. It also asked various merchants not to deduct a fee while someone pays from his debit card. It is nothing new and RBI had asked banks to stop this practice even earlier.

In the zero percent EMI schemes offered on credit card outstandings, the interest element is often camouflaged and passed on to customer in the form of processing fee. Similarly, some banks were loading the expenses incurred in sourcing the loan (viz DSA commission) in the applicable RoI charged on the product. Since the very concept of zero percent interest is non-existent and fair practice demands that the processing charge and RoI charged should be kept uniform product/segment wise, irrespective of the sourcing channel, such schemes only serve the purpose of alluring and exploiting the vulnerable customers. The only factor that can justify differential RoI for the same product, tenor being the same, is the risk rating of the customer, which may not be applicable in case of retail products where the RoI is generally kept flat and is indifferent to the customer risk profile.

Though many banks have appreciated our concerns and have discontinued with the above mentioned practices/ products, some of them still seem to persist with them. These practices/ products thwart the very principle of fair and transparent pricing of products which beholds customer rights and customer protection, especially, in the more vulnerable retail segment. Such practices thus violate, both in letter and spirit, various provisions of our MC on Interest Rate on Advances and therefore, you are advised to strictly desist from these practices hence forth.

ET has this edit on the move and as always criticises the move (as ET is strongly pro-markets):

The RBI has done immense disservice to industrial growth in the short term by asking banks not to offer popular financing schemes for consumer durables dressed up as zero-interest equated monthly instalment (EMI) schemes. Industrial growth has been extremely weak for an extended period and the forthcoming festival season is an opportunity for assorted consumer durable companies to step up their sales.

The zero-down-payment, zero-processing-fee, zero-interest EMI schemes an increasing number of companies offer on a variety of products are good for both consumers and for companies. The RBI’s move scuppers this opportunity to a large extent.

It is not the case that consumers are unaware that these financing schemes entail real costs on account of interest and documentation. They are aware that credit card-issuing banks charge a financing cost that product companies bear, to tempt consumers with “zero” offers. But this is not their concern. Nor should it be the RBI’s. If the RBI is worried about the rates banks offer, it is welcome to examine the banks’ books and ascertain if any rule is being violated.

Why should the bank regulator interfere with the behavioural economics at work when consumers prefer “zero” finance options on a higher price that bundles financing cost with the product price to the transparency of a lower product price and an explicit overlay of financing cost? Nor are consumers irrational. The cost would be lower, when borne by the company for multiple transactions all together, than when financing is offered to individual consumers.

It says Nor are consumers irrational..Really ET?

Well it seems the lessons from history have been forgotten very quickly. The several Americans who took sub-prime loans also were rational and did not need any intervention. Right? Wrong! The regulator is not interfering with bvevioral economics but is following behavioral economics. The field says we need to nudge when expectations are going crazy..

Further:

The only beneficiary from the RBI’s move is the buyer with sufficient purchasing power to not need a financing scheme, now that the product would be priced lower, taking out the financing cost by which price had been marked up earlier. Product sales and industrial growth would suffer, for the benefit of a tiny elite. This is a fetish for transparency that benefits no one except bean counters at the RBI. The RBI should withdraw these strictures gracefully and wish the economy a Happy Diwali.

Well it is fetish for growth which is the problem. Growth shd come at whatever cost. RBI is trying to not spoil Diwali but prevent Diwala (not literally though)… It is not asking people not to buy products but simply making sure people know the hidden costs. This is something rational people assume are not there but real world shows there is plenty of it..

Behavioral economics has shown the problems with the rational thinking and the crisis showed how rational people are..How many events do we need to debunk the idea of consumer rationality?

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One Response to “Behavioral economics and RBI’s move to ban zero financing on consumer durables…”

  1. Prof S P Garg Says:

    The Reserve Bank of India has taken this step very judiciously. Why 0% EMIs? banks and manufacturers or distributors need not to develop nexus to aggresively market their products.Credit card Issuers to promote their high interest business also offer such type of facilities to attract the customers.Ultimately the customer suffers in long run under the burden of high interests and service charges.
    NBFCs also need not to offer such facilities.The down payment, tenor, instalments, rate of interest etc must be realistic in terms of capacity of each borrower and base rate system adopted by individual banks.Festive season does not mean to play with the emotions of the consumers under the cover of behavioural weaknesses .

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