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Assessment Of The US Credit Card Industry

Jul. 17, 2013 4:37 AM ET
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Various proposals have been made in recent years to stabilize the provisions of the Fair Credit and Charge Card Disclosure Act of 1988 to offer more information to consumers. A legislative proposal to strengthen the act is issuers to print tables that show their credit card pricing terms on envelopes used in solicitations. That is not all; Bank Holders of America (BCHA), cardholder advocacy group, has argued that consumers need more information about issuers pricing practices. For example, research done by BCHA found that some issuers charge much higher rates for cash advances than for purchases yet they don't disclose this information in their solicitations. BCHA see the need for issuers to disclose the interest rate for cash advances.

Furthermore, BCHA has argued that some issuers use deceiving billing calculation procedures which result in excessively high interest charges to consumers. BCHA supports the ban of those billing practices. The advantage of reducing search costs is further disclosure requirements may benefit consumers who are willing to shop around for new cards and can qualify for lower rates. Several analysts have commented that the Fair Credit and Charge Card Disclosure Act of 1988 an increased mass mailings and publicity about the industry have probably lowered mass mailings search costs in recent years.

The cited proposals and others may reduce search costs even more. This does not mean that new disclosure requirements would definitely benefit cardholders whose credit histories prevent them from taking advantage of some attractive card offerings. New disclosure laws would also levy some additional regulatory charges on credit card issuers. For instance, if any changes to current disclosure requirements are made, issuers will be required to redesign their solicitations, billings, notices and possibly their envelopes. Critics of such disclosure requirements argue that raising costs on the credit card industry would not necessary benefit consumers. However, the Federal Reserve, when commenting on such disclosure requirements for the Fair Credit and Charge Card Disclosure Act of 1988, point out that such redesign costs are not necessarily substantial.

These costs are typically one-time expenses associated with changing solicitation notices to reflect new disclosure requirements. Therefore, any effort to strength disclosure laws would require careful consideration of whether customers would benefit and the costs credit card issuers would incur.

Establishment of a nationwide cap on Credit Card Interest rates

On various occasions, Congress has considered enacting a national cap on credit card interest rates top address alleged deficiencies in competition within the industry. Interest caps have been proposed to protect consumers from credit card interest rates that were viewed as unnecessarily high and as a means to stimulate the economy. Proponents of interest caps argue that failure of credit card interest rates to fall despite significant declines in both funding costs and the interest rates of other lending activities proved that the industry was not performing competitively.

Those who do not support government intervention in the credit card industry disagree imposing an interest rate cap is counterproductive and can lead to unintended consequences. Their argument is that issuers would respond by cancelling customer cards if they determine that an interest cap does not permit them to recover their full cost of operations. They would cancel cards that represent their greatest default risk.

Credit cards industry chart 1

Credit cards industry chart 2

Various studies show that an average interest rate cap, depending on the level it is set, would lead issuers to tighten their lending criteria. The RAM Research Corporation at Purdue University found that the loaning criteria of credit card issuers in Arkansas at the time had a usury limit of 10 percent.

The Credit Research Center found that issuers located in Arkansas were more likely to restrict their cardholder base to high-end earners compared to issuers in other states. The RAM Research Corporation found that credit card issuers with headquarters in Arkansas rejected 80 to 90 percent of all applications, restricted new customers to relatively low credit limits of $800 to&1000 and charged high annual fees of $35.

A study sponsored by the credit card industry found that if congress passed a rate cap of 14 percent, issuers would cancel credit cards of about 32 million cardholders. Historical experience show us that an interest rate cap could result in tightening of credit standards.

Allowing Credit Card Market to determine interest rate levels

Some policy makers suggest congress avoid intervention in the credit card market, instead permit market forces to determine interest rates. Proponent put their case forward that the industry is performing competitively and that competition is increasing. They say that a nonintervention policy would avoid risks associated with an interest rate cap, more so the cancellation of many credit cards. Evidence suggests the market is performing competitively. Such evidence include the number of issuers in the market, lower interest rates offered by major issuer and, the acceptable levels of concentration.

Proponents back their nonintervention policy by pointing to the entry of large nonbanks as evidence of increasing industry competition. A factor that points to increasing competition is consumers who found search costs prohibitive receiving improved information about interest rates, annual fees, and grace periods. However, there are various limitations to competitive developments that justify an interest cap. For example, even though two large issuers lowered their interest rates in the mid-1980s during the time of congressional scrutiny of the issuers pricing practices, they ended up raising their interest rates later in the decade. Intervention is justified to provide relief to riskier cardholders who, because they are "tied" to issuers have pegged their new low-rate cards to the prime rate, credit card interest rates offered.

Most issuers peg their new low-rate cards to the prime rate, thus credit card interest rates increase when the prime rate increases. New disclosure laws levy some additional regulatory costs on credit card issuers.

Processing of credit card transactions

During processing of credit card transactions, fixed fees are charged to the merchant, the merchant's bank and the card issuer. The merchant's bank subtract a "discount" fee of 1.9 percent of the total purchase price as compensation for proving credit card processing services to the merchant. An interchange fee of 1.3 percent of the total purchase price is paid to the depository institution that issues the credit card. MasterCard and VISA levy a fixed processing fee to merchant banks and the card issuers for using their computerized transaction settlement systems.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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