Marketing Styles of Financial Services - Research Paper Example

Introduction Ashton and Hudson tested the hypothesis that "price or interest rate clustering forms in retails markets as firms wish to maximise returns from customers, some of whom have difficulties in recalling and processing price information" (2008, p. 1393). The researchers found out that the clustering in the United Kingdom's financial markets is "consistent with firms maximising returns from customers" (Ashton & Hudson 2008, p. 1393). To put it bluntly, these firms are just taking advantage of the financial market's information asymmetry to increase their bottom line. Moreover, interest rate clustering appears to be beneficial to the price setter, but when taken in the aggregate very costly for the customers. Reduction in the incidence of interest rate clustering, however, is not very costly. Hence, Ashton and Hudson implied that the more na've customers should take a more active stance in their finances - be more involved as "[t]he degree of price or interest rate clustering appears to be exaggerate when low levels of financial involvement are concerned" (Ashton & Hudson 2008, p. 1402). In light of these findings, I have chosen to critically examine the extent to which Citibank UK and HSBC UK might be adopting unethical marketing approaches in setting interest rates. Citibank UK Citibank offers several savings and investment products, whether local currency denominated or foreign currency denominated, to its clientele. These savings and investments products are offered with range of interest rates. A look at the bank's Web page on its savings and investments products shows that its US Dollar Reward Saver is marketed as giving 2.50 per cent gross per annum rate which is much higher than the account's actual annual equivalent rate or AER of 2.02 per cent. Although both rates were published in the Web page, a na've customer - whose interest or whose lack of "ability to process information" (Ashton & Hudson 2008, p. 1393) is the one being exploited - would immediately zero in on the "earn up to 2.50% gross p.a. fixed for 6 months" (Citibank 2008) and ignore the subsequent "2.02% AER on your US Dollars in the UK2.50 per cent gross" (Citibank 2008). Clearly, in this example, the bank is playing in a very broad context of marketing ethics. Another example is the bank's Reward Saver Issue 2 product which is being offered at a gross per annum interest rate of 6.35 per cent while in reality, the customer will actually be getting an interest rate closer to 5.08 per cent which is the AER. Even the AER is structured in a way to maximise or to exploit the na've's customer's tendency to round up - in here, the na've customer would think that 5.08 per cent is substantially higher than 5 per cent. An example which provides proof to Ashton and Hudson's conclusion on the rounding - "If the number is not already a round number an individual would round a number to the closest reference number" (Ashton & Hudson 2008, p. 1394) - is the bank's net interest rate per annum for its 60 day direct savings account. The bank gives 2.48 per cent for accounts with more than '75,000. A customer with the characteristics described by Ashton and Hudson will immediately round this rate off to 2.5 per cent. The 0.02 per cent difference from the rounding off can be translated to '15 every year for a '75,000 account! Ashton and Hudson observed that for mortgage rates, the interest rate clustering "occurs very frequently just below round numbers giving strong evidence for the common use of na've number processing strategies" (Ashton & Hudson 2008, p. 1401). Unfortunately, for Citibank United Kingdom (and even for HSBC UK) I could not obtain interest rates for their mortgage products, hence I applied the findings of the research to the bank's credit card rates. For its Citi Platinum MasterCard, Citibank charges 5.8 per cent for balance transfers and an APR of 16.9 per cent which are examples of the observation made by Ashton and Hudson - clustering just below round numbers. This can also be observed in the bank's Citi AAdavatage Visa Gld Card which charges 5.8 per cent for balance transfers and 17.4 per cent APR - again, another interest rate clustering practice. This observation is perfectly aligned with Ashton and Hudson's conclusion on their model: "[t]o maximise profits from na've investors which truncate numbers it would be expected that interest rates are clustered at integers" (Ashton & Hudson 2008, p. 1396). Hence, the management of Citibank UK had clustered their interest rate of balance transfers to their credit card products to 6 per cent. The above observation is an example of truncating numbers information which Ashton and Hudson observed is more frequent or more relatively important than rounding for mortgage interest setting (Ashton & Hudson 2008, p. 1401). This might be because for mortgages and for any other type of loan, the customer will be the one paying the interests and truncating someone makes the interest rate lower than what it really is. As regards rounding off in terms of interest rates for savings and investment products, the na've customer usually rounds up since he or she will be the one receiving the interest payment. In other words, the na've customers is denuding himself or herself of thinking less whenever he or she is required to pay and of thinking more whenever he or she will benefit: "[d]eposit interest rates are effective prices which record benefits to consumers as opposed to the costs of a transaction to consumers (Ashton & Hudson 2008, p. 1395) which is the interest rates for loans. HSBC UK For HSBC United Kingdom, it is currently building up interest in its Online Bonus Saver savings account product. It is currently offering 3.25 per cent AER or annual equivalent rate to the customer if no withdrawals are made from the account, otherwise the customer gets 1.50 per cent. The difference in the interest rates, which is 1.75 per cent might convince the na've customer to open an Online Bonus Saver savings account and not make any withdrawals, however, the bank forget to inform the na've customer that it is giving much higher interests rates in some of its products such as the Cash e-ISA with a 4.25 per cent AER. As an example of Ashton and Hudson's observation on truncation, the bank is offering 1.95 per cent AER for its HSBC Premier Savings product. According to Ashton and Hudson, the "na've investor who truncates to the integer component of a number will regard" (2008, p. 1395) that interest rate as 2 per cent. Ashton and Hudson concluded that "[t]his attracts the same demand from na've investors but requires lower interest payments by the bank" (2008, p. 1395), hence more money available for lending and higher net income for the bank. This same practice in setting interest rates can also be observed in the bank's interest rates for tits credit card products. The bank advertises on its Web site that it charges 16.9 per cent APR or annual percentage rate for its credit cards, but that that rate is only applicable during the card's introductory period. The na've customer will think that all throughout the credit card's validity, he or she will only be paying 16.9 per cent charges. Moreover, the 16.9 per cent APR charged by the bank is an example of the interest rate clustering just below round numbers as observed by Ashton and Hudson and which I also observed practiced by Citibank United Kingdom. Ashton and Hudson also found out that "the degree of interest rate clustering varies with the amount of funds invested indicating clustering affects smaller savers to a greater degree" (Ashton & Hudson 2008, p. 1401) which is also consistent with the findings of other researches and studies. This observation appears to be through with HSBC UK. Under the bank's Reward Saver Account, it is offering a 2.04 per cent interest rate for '0 to '100,000 balances while for more than '100,000 the interest rate being offered is just 1.80 per cent. Conclusion As proven by numerous studies including the research done by Ashton and Hudson, banks and other price setters will always find a way to exploit the naivet' of the average customer. Like any other type of information asymmetry, a lot of money can be made from it. Hence, putting in some form of rules or law regulating how banks and players in the financial markets exploit the behaviors of customers will be ineffective at best. Perhaps, the best way to render interest rate clustering in retail banking markets ineffective is to educate the customers themselves, educate them that really 2.35 per cent is really 2.35 per cent and not 2.4 per cent. Customers who are "more na've and less informed" (Ashton & Hudson 2008, p. 1402) who "are least able to recall and process number information accurately" (Ashton & Hudson 2008, p. 1402) must be given all the help they need to overcome their difficulty in processing numbers. This approach, although not discussed by Ashton and Hudson, is much more practical than "a public welfare case to more closely administer firms which set prices in a clustered manner" (Ashton & Hudson 2008, p. 1402). If no action is taken "na've customers may currently lose up to 99 basis points due to their bounded rationality which is clearly an economically significant loss" (Ashton & Hudson 2008, p. 1402). 'Educating' the customers, however, is very urgent - it must be done soon. This is so because the financial markets we have right are becoming more and more sophisticated. New and never heard of financial products and services are being offered everyday and price setting or interest rate clustering for these new products is inevitable. If no action is taken in educating the more na've customers, there will come a time when those customers will also be having problems assessing other information about financial services. As presented in the discussions of the extent to which Citibank UK and HSBC UK adopted unethical marketing approaches in setting the interest rates for their different products, I showed different examples of truncating and rounding - two of the three models developed by Ashton and Hudson. Unfortunately, I could not find any example for both bank for the third model, both truncation and rounding. Perhaps, other banks might be taking advantage of the truncation and rounding practices of customers in setting their interest rates. Lastly, the findings of John K. Ashton and Robert S. Hudson are very interesting and very valuable for "academic consideration, policy discussion and potentially regulatory investigation" (Ashton & Hudson 2008, p. 1402). However, it would have also been interesting if Ashton and Hudson devoted a few paragraphs on the discussion on how price or interest rate clustering came about. This discussion might be of help to those who are interested in minimising the cost of interest rate clustering to the financial markets' customers. Works Cited Ashton, J. K. & Hudson, R. S. 2008, 'Interest rate clustering in UK financial services markets', Journal of Banking & Finance, vol. 32, no. 7, pp. 1393-1403. Citibank 2008, 'Citibank Savings and Investments', Available at: http://www.citibank.co.uk/personal/banking/saveinvest/'merchant=citi. Read More