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Price-increasing competition: the curious case of overdraft versus deferred deposit credit

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Abstract

We find that banks charge more for overdraft credit when depositors have access to a potential substitute: deferred deposit (\\"payday\\") credit. We attribute this rise in prices partly to adverse selection created by banks' practice of charging a flat fee regardless of the overdraft amount--pricing that favors depositors prone to large overdrafts. When deferred deposit credit priced per dollar borrowed is available, depositors prone to small overdrafts switch to that option. That selection works against banks; large overdrafts cost more to supply and, if depositors default, banks lose more, so prices rise. Consistent with this adverse-selection hypothesis, we document that the average dollar amount per returned check at banks and other depository institutions increases when depositors have access to deferred deposit credit. Beyond documenting another case of price-increasing competition, our findings bear on theories of adverse selection in credit markets and contribute to the debate over the pros and cons of payday credit.

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  • Brian T. Melzer & Donald P. Morgan, 2009. "Price-increasing competition: the curious case of overdraft versus deferred deposit credit," Staff Reports 391, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednsr:391
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    Cited by:

    1. Jacint Balaguer & José Pernías, 2011. "Measuring the effect of local competition on prices in a context of spatial differentiation," Letters in Spatial and Resource Sciences, Springer, vol. 4(2), pages 109-116, July.
    2. Marc Fusaro & Richard Ericson, 2010. "The Welfare Economics of “Bounce Protection” Programs," Journal of Consumer Policy, Springer, vol. 33(1), pages 55-73, March.

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    Keywords

    Bank competition; Overdrafts; Banks and banking - Service charges; Bank deposits;
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