Americans’ trust in the banking sector has collapsed this century, with the percentage of US adults with high confidence in banks tumbling from 53% in 2004 to 10% in 2023, following the Financial Crisis of 2007-09: Largely attributable to a housing market bubble driven by subprime mortgages, the Financial Crisis of 2007-2009 was a period of severe economic downturn and financial market stress that originated in the United States and quickly spread globally. It was the most significant economic downturn since the Great Depression of the 1930s, earning it the moniker, “Great Recession.” and the Silicon Valley Bank failure: The Silicon Valley Bank (SVB) crisis was the third-largest US bank failure in history, occurring in March 2023 after a run on deposits led to its seizure by regulators. The crisis was triggered by the bank’s large portfolio of long-term, low-yield securities that lost significant value when the Federal Reserve raised interest rates to control inflation. This, combined with a downturn in the tech sector and widespread panic, caused customers to rapidly withdraw funds, prompting the bank to sell assets at a loss, and ultimately leading to its collapse. . Further, 56% believe that the government does not do enough to regulate financial institutions. More than just a popularity poll, these numbers have implications for whether and how retail customers: In banking, retail customers are individual consumers, rather than businesses, who receive financial services from a bank, including access to credit and borrowing, deposit opportunities, and money management advice. choose to work with banks. In this new work, the authors explore one key question that is largely ignored in the literature: Has the decline in trust influenced customers’ decisions to borrow from banks?
To begin, the authors offer the following definition of trust, based on prior literature: “the expectation that another person (or institution) will perform actions that are beneficial, or at least not detrimental, to us regardless of our capacity to monitor those actions.” Given this definition, trust in the banking industry can be compromised through concerns about bankers’ motives or banks’ operational reliability. To the question at hand, given the complexity of a loan agreement and the degree to which customers likewise must rely on banks’ integrity, distrustful borrowers may be disinclined to borrow.
Measures of trust in banking are generally survey-based and tend to be regional or economy-wide rather than bank-specific and so describe notions of generalized rather than personalized trust (i.e., trust in a particular institution). The authors address this gap through a novel approach that allows them to study enforcement actions (also referred to as enforcement decisions and orders, or EDOs: Directives issued by regulatory agencies to force a financial institution or individual to take corrective actions to comply with laws and regulations, resolve violations, or prevent unsafe practices. ) issued by US bank supervisors against financial institutions. Importantly, EDO banks suffer significant reputational damage, as enforcement actions are publicized in the local news media and on regulators’ websites. This allows the authors to exploit the coverage and quality of local information to study the effect of declining trust on retail borrowers’ financial decisions.
Specifically, the authors use granular data on auto loans from a credit reporting agency, which links borrowers and lenders, including on a geographic basis, allowing the authors to examine geographic variation in trust for the same EDO. Auto loan pricing can be complex as rates vary based on the borrower’s credit, loan structure, and vehicle type, forcing borrowers to rely on banks to interpret loan terms. Promotional offers and add-ons often obscure the actual cost of financing and inflate expenses, making it difficult for borrowers to identify the full cost of the loan. Further, loan providers may overcharge for add-on products, wrongfully repossess vehicles, and mislead customers about loan payments, all stressing the importance of borrowers’ trust in banks in the auto loan market. The authors find the following:
- New loans originated following an enforcement action are of relatively lower quality and become delinquent 28% sooner than those originated by control banks. The results are concentrated in the first year of the enforcement action, suggesting that consumers react to news of the EDO.
- This downward shift in the quality of originated loans and new borrowers while an enforcement action is open suggests that higher-quality borrowers avoid transacting with enforced banks. Higher-quality borrowers are more likely to react to changes in trust because they have more options, including access to multiple sources of credit, and are likely to be more sensitive to perceived changes in service quality.
The authors provide the following evidence that trust is at the heart of these findings:
- Survey data reveal that enforcement actions are associated with significant declines in trust in banks and bankers. The shift toward lower-quality borrowers during enforcement actions only occurs in regions that witness a decline in trust based on the survey-based measure.
- The authors quantify negative and positive sentiments, including trust, from local news articles discussing bank enforcement actions.
- Finally, the authors use variations in the quality of local information access. Their results do not hold in regions with no local newspaper coverage. In such regions, consumers are unlikely to learn about enforcement actions, so their trust in banks should not be affected.
By extending the literature on how confidence in banks influences consumers’ decisions, including the influence of local media, this paper raises important questions for further research, especially regarding potential effects on local GDP, credit markets, or employment.