Precommitments for Financial Self-Control? Micro Evidence from the 2003 Korean Credit Crisis

We analyze installment borrowing decisions from two random samples of customers of a credit card company before and after the 2003 credit crisis in Korea. In an attempt to increase its market share, the company more or less randomly offers its customers free installments, i.e. opportunities to pay off card purchases in up to twelve monthly installments at a zero interest rate. We exploit these offers as a quasi-random field experiment to better understand consumer demand for credit. Despite censoring in the data (we observe free installment offers only when customers choose them), our econometric model is able to separately identify the probability a customer is offered a free installment opportunity from the probability they take it. We find that the company sharply reduced free installment offers after the crisis, while customer take-up rates increased from an average of 13% before the crisis to 20% after it. Among the minority of customers who take the interest-free loan offers, most precommit to repay the loan over a term that is shorter than the maximum allowed under the offer. This behavior is puzzling given that there are no pre-payment penalties and these offers can be easily accepted at the push of a button at the check out counter. Rational expected utility maximizers should take every interest-free loan offer for the maximum allowed term if the transaction cost of taking the offer is zero. A possible explanation of this behavior is that customers, in an exercise of financial self-control, resist the temptation of interest-free loan offers to avoid becoming excessively indebted.