The Review of Financial Studies /v 26 n 2013 unemployment and sickness)and therefore can be beneficial. * However, access to high cost credit can pose a danger for financially fragile households if they borrow too much, relative to their means. The evidence reported in this paper provides novel insights on(1) the prevalence of liquidity constraints and(2) the mechanism of debt accumulation among subprime borrowers in developed economies. Such insights are critical to the development of public policy and consumer protection actions targeting financially vulnerable households in the United Kingdom and other developed economies From a policy point of view, the results illustrate(1) the vulnerability of subprime borrowers to interest rate increases and (2)that interest rate increases would be profitable for the lender for almost all types of borrowers studied.6 Whereas imposing interest rate caps might be an unpalatable option for a policy maker(because it could result in credit rationing), a range of other policy interventions might aid these individuals. These include restrictions on credit limit increases(particularly, limit increases initiated solely by the lender) and higher required minimum payments. A policy that requires lenders to fully explain and illustrate the consequences of higher interest rates on debt on might also be beneficial The rest of the paper is organized as follows. We provide a brief overview of the U. K. credit card market in the next section. In Section 2, we present our data and the experimental design. In Section 3, we motivate our outcome rariable and assess the magnitude of expected response to the experiment. We present and discuss the results in Section 4, and Section 5 concludes 1. Subprime Credit Card Market in the United Kingdom Credit cards have steadily grown in importance as a payment device in all industrialized countries. As of 2007, it is estimated that approximately 70 million credit cards were in issue in the United Kingdom. These cards were responsible for 22.4%o of the total consumer transactions, which stood at f540 billion in 2007(see Data monitor 2008). Moreover, borrowing on credit cards(revolving credit card debt from one month to the next and therefore incurring interest charges) has grown rapidly over the last few decades in the 4 Karlan and Zinman (2010) show that access to consumer credit even at very high rates can be beneficial.The ndomly assigned marginal loans produced significant net benefits for borrowers across a wide range of outcomes South afric emand elasticities in South Africa and Bangladesh, respectively. Karlan and maturity. Dehejia, ry, and Morduch(2012)estimate subtantial interest rate sensitivity among the poor. 6 A caveat applies to this result as the implications of the lender's profitability are based on short-run estimates. It is plausible that a permanent increase in interest rates has different long 2356 Downloadedfromhttps://academic.oupcam/rfs/article-abstract/26/9/2353/166253 e[16:30 29/7/2013 RFS-hht029.tex] Page: 2356 2353–2374 The Review of Financial Studies / v 26 n 9 2013 unemployment and sickness) and therefore can be beneficial.4 However, access to high cost credit can pose a danger for financially fragile households if they borrow too much, relative to their means. The evidence reported in this paper provides novel insights on (1) the prevalence of liquidity constraints and (2) the mechanism of debt accumulation among subprime borrowers in developed economies. Such insights are critical to the development of public policy and consumer protection actions targeting financially vulnerable households in the United Kingdom and other developed economies.5 From a policy point of view, the results illustrate (1) the vulnerability of subprime borrowers to interest rate increases and (2) that interest rate increases would be profitable for the lender for almost all types of borrowers studied.6 Whereas imposing interest rate caps might be an unpalatable option for a policy maker (because it could result in credit rationing), a range of other policy interventions might aid these individuals. These include restrictions on credit limit increases (particularly, limit increases initiated solely by the lender) and higher required minimum payments. A policy that requires lenders to fully explain and illustrate the consequences of higher interest rates on debt accumulation might also be beneficial. The rest of the paper is organized as follows. We provide a brief overview of the U.K. credit card market in the next section. In Section 2, we present our data and the experimental design. In Section 3, we motivate our outcome variable and assess the magnitude of expected response to the experiment. We present and discuss the results in Section 4, and Section 5 concludes. 1. Subprime Credit Card Market in the United Kingdom Credit cards have steadily grown in importance as a payment device in all industrialized countries. As of 2007, it is estimated that approximately 70 million credit cards were in issue in the United Kingdom. These cards were responsible for 22.4% of the total consumer transactions, which stood at £540 billion in 2007 (see Data monitor 2008). Moreover, borrowing on credit cards (revolving credit card debt from one month to the next and therefore incurring interest charges) has grown rapidly over the last few decades in the 4 Karlan and Zinman (2010) show that access to consumer credit even at very high rates can be beneficial. The randomly assigned marginal loans produced significant net benefits for borrowers across a wide range of outcomes in South Africa. 5 The evidence on the credit elasticities of financially vulnarable households is limited, but there is a large body of academic literature on estimating credit elasticities in developing countries. Using a field experiement, Karlan and Zinman (2008) and, using between-branch variation, Dehejia, Montgomery, and Morduch (2012) provide evidence on the size of credit demand elasticities in South Africa and Bangladesh, respectively. Karlan and Zinman (2008) estimates modest interest rate sensitivity of the demand for new term loans in South Africa, with demand apparently more sensitive to loan maturity. Dehejia, Montgomery, and Morduch (2012) estimate subtantial interest rate sensitivity among the poor. 6 A caveat applies to this result as the implications of the lender’s profitability are based on short-run estimates. It is plausible that a permanent increase in interest rates has different long-run consequences, such as default or driving away clients. 2356 Downloaded from https://academic.oup.com/rfs/article-abstract/26/9/2353/1662534 by Fudan University user on 14 December 2017