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

Brian Melzer and Donald Morgan

No 391, Staff Reports from Federal Reserve Bank of New York

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.

Keywords: Bank competition; Overdrafts; Banks and banking - Service charges; Bank deposits (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-ban, nep-bec, nep-cfn, nep-com and nep-mic
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Citations: View citations in EconPapers (2)

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