Credit card lending in the UK amounts to £65 million, but a significant number of credit card customers only make minimum repayments each month. Around four million accounts are in persistent debt. This can trap people in long-term debt, unable to make much headway on reducing the outstanding balance, which is both economically costly and potentially damaging to their wellbeing.
The Economic and Social Research Council (ESRC) funded research by Professor Neil Stewart, Warwick Business School at the University of Warwick, investigated decision making around credit card repayments. His analysis of huge data sets of card transactions, coupled with consumer trials of interventions, informed the introduction of new rules by the Financial Conduct Authority (FCA). This is helping to shape practices of credit card companies to offer better services to their customers.
The FCA estimates the new rules will save consumers between £310 million and £1.3 billion a year in lower interest charges, helping break the cycle of persistent credit card debt for thousands of people.
About the project
Working out the interest of credit card debt over the course of time involves calculations that many people cannot, or will not, easily perform. Instead, they make complex, but not always logical, decisions about the amount they will repay. Exploring these behaviours requires a combination of behavioural science and economics, says Professor Stewart:
We’re not calculators; we can’t do those sorts of sums in our heads, so people use all sorts of strategies to decide what they’re going to repay each month. We can see evidence of those strategies in credit card statements.
Professor Stewart analysed data from millions of anonymised credit card transactions from five of the UK’s largest card providers. This built on his earlier research into the ‘anchoring’ effect of minimum payments published on the Warwick Business School website. He explains:
Suggesting a minimum payment often results in people paying that figure or just above – it ‘anchors’ them to that amount. In experiments, we found that if no minimum payment is suggested, people choose to pay on average 20% more.
Findings also revealed that many missed credit card repayments are simply the result of people forgetting to pay, rather than being unable to pay. For the approximately 10% of consumers that set up direct debits to avoid forgetting minimum payments, the reduction in fees is offset by the interest charged over time (Warwick Business School).
Working with the FCA, Professor Stewart designed and undertook large-scale trials of interventions, which demonstrated that concealing minimum payments changed consumer repayment behaviour. However, a significant proportion of people set up a fixed-sum direct debit which, although larger than the minimum payment, did not take into account accruing interest and so did not reduce overall debt levels a year on.
Impact of the project
Professor Stewart’s research on consumer decisions in the credit card market has reshaped the UK’s approach to credit card repayments, positively impacting consumers and improving the practices of card firms.
New rules introduced by the FCA
Professor Stewart’s research directly informed changes the FCA made to its rules and guidance for credit card companies. Implemented in 2018, card providers must now encourage consumers to repay more, with nudges at 18 and 27 months, and take stronger action to clear a debt in three to four years.
In addition, the FCA is considering changing guidance to mandate the complete removal of the minimum repayment anchor. Dr Stefan Hunt, former Head of Behavioural Economics and Data Science at the FCA, says:
[Professor Stewart’s] work has directly and substantially impacted a number of very important parts of the FCA’s policy formation… The FCA subsequently drew upon [analysis of consumer behaviour in the credit card market], which was cited in the final report. In particular, the analysis of minimum repayment rules has directly influenced the design of our proposed remedies.
Empowering consumers to reduce debt
The FCA changes informed by Professor Stewart’s research will save consumers millions of pounds in interest charges and fees, with the biggest reductions for those with large persistent debt.
Drawing on evidence from Professor Stewart’s research, the FCA has provided guidance for consumers to enhance their awareness of the real cost to them of making minimum repayments.
Improving practices of card firms
The FCA’s Consumer Duty guidance requires financial service firms to put their customers’ needs first. Professor Stewart’s research was an early example of using field trials as the gold standard for evidence in changes to policy.
Professor Stewart explains:
As part of our work with the FCA, we demonstrated how these trials should be conducted. The FCA is now looking to banks to demonstrate in a similar way the evidence that their products are good for customers. A legacy of this work is in how financial companies are using behavioural science to understand consumer behaviour and shape their products accordingly.
Video credit: ESRC
Video transcript and on-screen captions are available by watching on YouTube.
Find out more
The cost of anchoring on credit-card minimum repayments (Sage Journals).
New credit card rules introduced by the FCA.
Top image: Credit: LaylaBird, E+ via Getty Images