Transparency of contracts is lacking in the financial market

Thousands of people have problems repaying the money they have borrowed from financial institutions. They often do not fully understand the contracts they enter into. Credit card contracts alone currently number tens of thousands of words. Economists are therefore looking for ways to help the so-called naive consumers who are paying the price. They have found that the most effective way is to push for transparency. Results come faster this way and other clients are only minimally harmed. This is according to a recently published SYRI study on the financial market.

There is a paradoxical situation in the market. On the one hand, there are naive consumers who do not assess their options well and do not understand the key features of their contracts, making them vulnerable to costly penalty fees. "On the other hand, there are sophisticated consumers who are essentially subsidised by the financial mistakes of others, as financial investments must set terms that are acceptable to both groups. The overpayment of fees by naive borrowers then indirectly favors sophisticated clients through lower interest rates," said Alexander Hansak of the National Institute of SYRI and CERGE-EI.

Economists have compared two basic regulatory frameworks that can address the problem. The first is greater transparency of contracts, the second is capping fees. "When comparing the effects of these two policies on the magnitude of naive consumers' mistakes, we find that transparency requirements are more effective because we achieve significant results in a simpler way. At the same time, it does not lead to any dramatic deterioration in conditions for sophisticated clients," Hansak said.

So, while fee capping may be a simpler policy at first glance, improving the language of financial contracts and raising standards for transparency and information requirements seems like a better solution. "These interventions strengthen consumers' ability to make informed decisions while maintaining a flexible and competitive lending environment," Hansak said.

One of the main sources of financial mistakes is the misperception of the total cost of the loan. "Regulatory measures that increase the clarity and transparency of contract terms - such as standardised disclosure formats, simplified pricing structures or the use of simpler language - can then significantly reduce the frequency and cost of errors. The results show that these transparency-focused policies can substantially improve the decision-making of naive consumers without significantly harming the welfare of sophisticated borrowers," Hansak added.

Link to the Study: https://1url.cz/kJBNh