BIS paper: banks may harm customers through ‘steering’

Banks may be able to benefit from “steering” their customers towards certain products, but this can harm people’s welfare, a working paper published by the Bank for International Settlements finds.

The cost of steering in financial markets: evidence from the mortgage market analyses steering by Italian banks. Steering can take many forms – it might be as simple as explaining a complex financial product, but it could also involve shrouding some aspects of a product to distort a customer’s choice.

The authors build a model of both “sophisticated” and “naive” households, with the latter being less likely to fully understand the pros and cons of mortgage products.

With about 48% of Italians falling into the “naive” bracket, and banks enjoying significant market power, the authors estimate steering by banks costs the average Italian household €661 ($739) per year. The cost is much higher for naive households, at €1,745, versus a net benefit of €295 for sophisticated households, who can exploit banks’ rate structures.

Intervention by the government to restrict steering can actually make the situation worse, the authors find, as steering by banks does convey some useful information. But education campaigns always boost welfare.