When lenders compete for your business, do we win?

If you have poor credit and need to buy a car, then yes, this experiment shows that you win when more lenders compete for your business. But the results are more nuance. Credit unions specialize in consumer lending, and when they expand into a local market under this regulatory experiment, the typical incumbent bank switches to making more business loans. But switching the business in the face of more competition is not easy, and weaker banks are also more likely to fail when credit unions enter. Consumers though benefit. Lending rates for riskier collateral, like used cars, decline and deposit rates increase.

But banks and credit unions make up only part of our financial system. Shadow banks—unregulated lenders such as captive finance companies and private pools of capital—also play a hugely important role in providing consumer credit. And their response to increased competition differs sharply from banks. With little alternative lending opportunities, and no regulatory constraints on asset quality, these institutions fight for market share by greatly expanding credit to subprime auto borrowers. These shadow banks then turn around and securitize the subprime car loans—bundle the loans together and sell claims on their cash flows to Wall Street investors.

No one knows whether this increase in subprime lending on account of greater competition is “good” . Because of their improved credit access, poorer households can now upgrade their car and perhaps get to work more easily and safely. But much of this subprime auto lending is unprecedented. And with little past experience to go on, if defaults rise and these securitized products begin to do poorly, the effects on the financial system could be large. If you see parallels to the subprime housing story 10 years back, so do I. Here is a copy of the paper, judge for yourself.