Financial Illiteracy and customer credit history.
| Autor | Santos, Danilo Braun |
1 Introduction
The Brazilian Central Bank and Serasa Experian have recorded increasing rates for the total number of credit defaults or payment delays over the last few years in Brazil. They estimate that there were 61.8 million Brazilians with a credit default or derogatory mark on their credit history in June 2018 (Serasa Experian, 2018). The increase in defaults raises concerns both for the country's financial and economic health.
Credit default problems are caused and intensified by financial illiteracy (Anderloni & Vandone, 2010; Gerardi, Goette, & Meier, 2010). In Brazil, most of the studies focus on the efficiency of the models for predicting default risk. Issues related to the causes of defaults and consumer behaviour patterns are barely studied by academics and the public sector. We tackle the relationship between financial illiteracy and defaults by using individual investment choice and consumer credit history.
Regardless of the degree of development of each country's financial market, financial education is precarious around the world. Individual defaults can lead to the financial exclusion of individuals (Lusardi & Mitchell, 2011). Brazil has two credit default lists: SPC and Serasa. Derogatory marks increase the risk of debtors having their credit applications denied and being deprived of basic financial instruments and services, such as opening a checking account, thus causing social exclusion (Anderloni & Vandone, 2010).
The Brazilian government created the National Financial Education Strategy (or ENEF, the acronym in Portuguese) through Federal Decree n. 7,397/2010 to spread financial education via a free and permanent program, capable of helping individuals make more autonomous and conscious financial decisions. The strategy was created through the interaction of eight government agencies and four society organizations. Together, they are part of the National Financial Education Committee (CONEF). This initiative followed the lack of a structured financial education program before 2010 and highlights the importance of financial literacy to ease the growing credit default problem.
Measuring financial literacy is a complex issue. Lusardi and Mitchell (2011) understand that although it is important to assess the degree of financial literacy of individuals, in practice, it is difficult to explore how they process financial information and apply it to their daily decisions. Lusardi and Mitchell (2013, 2014) define financial literacy as the ability to understand economic information and make decisions about debt, investments, and financial planning. Moore (2003) argues that individual levels of financial literacy cannot be measured directly. For this reason, he recommends the use of proxies to identify whether the individual has satisfactory financial literacy. Therefore, this paper will follow Santos et al. (2018) and use capitalization bonds (titulos de capitalizacao, in Portuguese) as a proxy for financial literacy.
Capitalization bonds are often seen as an alternative with the same output as a savings account and most of the time they are sold using this argument. However, only part of the investment is effectively capitalized, the so-called capitalization quota, while in a savings account the entire value invested is capitalized. The main function of the interest rate in a capitalization bond is to define the percentage of the capital that the consumer will be entitled to in case of early redemption. If the bond is redeemed at maturity, the investor will receive the capitalization plus interest and will always receive 100% of the amount paid for the security. A financially literate individual will choose to invest in a savings account over a capitalization bond as a saving account has a superior yield and similar risk. We argue that only financially illiterate individuals will invest in capitalization bonds.
Our main hypothesis is that financially illiterate individuals have more chance of being added to a default list and having a derogatory mark. We use investment in capitalization bonds as a proxy for financial illiteracy to determine the probability of a derogatory mark on the customer's credit history. Our main result is that financially illiterate individuals have between 57% and 143% more chance of having a derogatory mark on their credit history depending on the choice of controls. Despite being prohibited, joint sales of capitalization bonds and other bank products are common in Brazil. We use a bank loan dummy to reduce any possible endogeneity between capitalization bonds and a derogatory mark through joint sales.
We find other meaningful insights to explain the probability of a derogatory mark on a customer's credit history: older individuals have 16% more chance of having a derogatory mark, but this marginally decreases by 1%; married individuals have 40% less chance; individuals with a higher income have 15% more chance; formally employed individuals have a slighter higher probability than informally employed ones; and retired individuals have at least 178% more chance of having a derogatory mark.
This article is organized as follows: Section 2 briefly describes the relationship between credit defaults, financial literacy, and capitalization bonds and how they work. Section 3 explains our methodology, data, and variables. Section 4 presents our results. Section 5 concludes the paper.
2 Defaults, Financial Literacy, and Capitalization Bonds
2.1 Brazilian defaults
The Serasa Experian Consumer Default Indicator reflects default behaviour in Brazil and recorded a 1.98% rise in defaulters in June 2018 compared to the previous year. The indicator found that 38% of all defaults are due to nonpayment of bank loans and leases, 31% account for utilities, 11% for services, 13% for retail, and 7% for other reasons. In Brazil, 40% of the population has a default and on average each defaulter has four debts (Serasa Experian, 2018).
The Consumer Indebtedness and Default Survey (PEIC) is a survey of 18,000 consumers carried out monthly by the National Confederation of Commerce of Goods, Services, and Tourism (CNC). In May 2018, 59% of households had debts involving credit cards, overdrafts, retail, personal loans, and insurance. The percentage of households that had outstanding debts was 24% of the total. In the survey, 10% of all families reported that they could not pay their debts and would remain in default (CNC, 2018).
2.2 Financial literacy
Financial illiteracy reinforces negative credit behaviour, such as excessive debt accumulation and high-cost borrowing (Lusardi & Tufano, 2009), poor mortgage choices (Moore, 2003), losing one's home due to non-payment (Gerardi et al., 2010), poor investment choices (Bellofatto, D'Hondt, & Winne, 2018), and suboptimal borrower behaviour (Bajo & Barbi, 2018). Anderloni and Vandone (2010) understand that financial education plays a fundamental role as a preventive measure for controlling defaults, since it increases individuals' understanding of their financial decisions, making them better able to make financial choices. Gerardi et al. (2010) find a strong and significant correlation between a lack of knowledge in mathematics and mortgage defaults in the US, suggesting that financial illiteracy played an important role in the subprime crisis. Also, Garmaise (2015) shows that defaults are more likely for borrowers who give incorrect information when taking out loans, e.g., they report more assets than they really have, evidencing a lack of control over their personal finances.
Gathergood (2012) highlights a positive relationship between high levels of indebtedness and consumer behavioural issues, such as a lack of self-control and financial disorganization. Individuals lacking self-control and financial organization use quick and easy credit instruments such as credit cards and retail credit cards, not realizing the high costs and buying impulsively without worrying about future instalments. Also, Achtziger, Hubert, Kenning, Raab, and Reisch (2015) find that women are more prone to buying compulsively than men. Consumers may develop financial trauma, reducing their self-esteem and optimism in the face of financial questions (Mewse, Lea, & Wrapson, 2010), which could reduce their wellbeing (Brown, Taylor, & Price, 2005).
Measuring financial literacy is a complex issue. Lusardi and Mitchell (2011) understand that although it is important to assess the degree of financial literacy of individuals, in practice, it is difficult to explore how they process financial information and apply it to their daily decisions. Moore (2003) argues that each individual's level of financial literacy cannot be measured directly. For this reason, he recommends the use of proxies to identify whether the individual has satisfactory financial literacy. Therefore, this paper will use capitalization bonds as a proxy for financial literacy.
2.3 Capitalization bonds (titulos de capitalizacao)
Capitalization bonds are nominative securities, which can be purchased on a timeshare basis or on a unique payment basis. With this product the payments made by the subscriber are used to form the capital (capitalization quota), which is refunded at maturity plus interest. The remainder of the amounts paid are used to pay for sweepstakes and administrative expenses (Superitendencia de Seguros Privados [SUSEP], http://www.susep.gov.br/2015, retrieved on 30 September, 2019). Currently, 17 million individuals have capitalization bonds. This market encompasses a broad universe of consumers, regardless of social class, income, or education (FenaCap, 2016).
Capitalization bonds are viewed and used by banks as a strategic tool to retain their relationship with their clients (Angst & Abreu, 2007). They are a way to save money and still participate in...
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