The cost of steering in financial markets: evidence from the mortgage market

Focus

Many households lack the expertise they need to make complex financial decisions. As a result, they are more susceptible to being steered by banks towards certain financial products via advice, advertising or shrouding among other gambits. This study analyses the effects of so-called steering by banks on consumer welfare, focusing on the choice between plain vanilla fixed and adjustable rate mortgages. Using a structural model for Italy, we ask if banks' steering activity works differently on clients with differing degrees of financial sophistication.

Contribution

In our model, each bank builds its optimal mortgage portfolio by both setting rates and steering customers. "Sophisticated" households know which mortgage type is best for them, while "naive" ones are susceptible to steering by their bank. Using data on Italian mortgages, we estimate the model and quantify the welfare implications of steering.

Findings

We find that banks' steering activity may generate distortions. Its welfare effects vary across households, depending on their sophistication. Yet measures to restrict banks' scope for steering their customers would not necessarily increase household welfare. This is because such steering activities, even if potentially distortive, do generally convey some useful information. However, a financial literacy campaign always has a beneficial effect on the welfare of naive households, which are proportionately more exposed to the risk of taking inappropriate financial decisions.

Abstract

We build a model of the mortgage market where banks attain their optimal mortgage portfolio by setting rates and "steering" customers. "Sophisticated" households know which mortgage type is best for them, while "naïve" ones are susceptible to steering by their banks. Using data on the universe of Italian mortgages, we estimate the model and quantify the welfare implications of steering. The analysis shows that banks' steering activity could generate distortions, with welfare effects that vary between households depending on their degree of sophistication. However, the introduction of measures to restrict the scope for banks to steer their customers would not necessarily increase household welfare, because such activities, even if potentially distortive, may also contain useful information. By contrast, a financial literacy campaign always has a beneficial effect on the welfare of naïve households, which are proportionately more exposed to the risk of taking inappropriate financial decisions.

JEL codes: G21, D18, D12

Keywords: steering, financial advice, mortgage market, consumer protection