Do Lenders Cross-Subsidise Loans by Selling Payment Protection Insurance?

Abstract

This study examines the recent UK regulatory decision to ban the joint provision of consumer lending and payment protection or credit insurance (hereafter PPI). This case has wide regulatory implications following concerns that the sale of PPI has been detrimental to customers due to overpriced PPI and a cross-subsidy flowing from PPI to unsecured lending. The study examines whether interest rate setting of unsecured lending is influenced by banks issuing PPI or otherwise to help establish whether such cross-subsidies have been made. This assessment is undertaken over time for a diverse and comprehensive selection of banks offering unsecured lending with and without PPI between 1998 and 2011 for three levels of borrowing. It is reported that offering PPI is a significant explanatory variable of unsecured lending interest rate levels. When unsecured lending is offered with PPI, interest rates are lower, a finding consistent with a cross-subsidy flowing from PPI remiums to unsecured lending.

Key Words:

• Universal Banking
• Credit Insurance
• Add-on Goods
• Joint Pricing
• Payment Protection Insurance.

• JEL classifications
• G21
• G22.

Notes

1. These measures were largely upheld in a provisional decision by the Competition Appeal Tribunal published in May 2010 after an appeal by Barclays bank in October 2009 on the grounds that prohibiting the joint sale of PPI reduced customer convenience (CC, 2010). A detailed legal discussion of this case is provided by Grey (2011). This blanket prohibition has also led the Financial Services Authority to issue a consultation document on assessing compensation for customers’ mis-sold PPI with lending (FSA, 2010).

2. The relevant UK regulator was the Financial Services Authority until 1 April 2013 when its role in retail regulation was transferred to the Financial Conduct Authority.

3. A wider discussion of customer redress in consumer financial markets is provided by Adams and Hunt (2013).

4. It is acknowledged that Durkin (2002) indicated cross-selling lends itself to coercive sales, and PPI sales have focused on older and lower socio-economic groups – groups particularly prone to coercion (Barron and Staten, 1995). Similarly, De Meza, Irlenbusch, and Reyniers (2007) report the approach adopted by PPI sales persons can influence purchase decisions. These studies, while identifying the PPI market as fertile ground for coercive sales, have not empirically tested for the presence of such sales. As indicated in the text, survey evidence for the UK and the United States, and repeated FSA investigations reported as final notices of regulatory action, all indicate assumptive sales rather than coercive sales is the dominant sales method in this market.

5. These values for borrowing erode over the sample period due to the effects of inflation where £1,000, £5,000 and £10,000 in 1998 are worth £692.60, £3,463.01 and £6,926.02 in 2011 when deflated by the Retail Price Index.

6. This test is undertaken using the Stata procedure TestParm.