US consumers are paying higher interest rates on their credit card balances than they have in more than a quarter-century, and the Federal Reserve’s rate cuts are no guarantee that they will receive much relief.
The average rate on interest-bearing card accounts topped 17 per cent in May, according to Fed data, the highest in the 25 years that the central bank has been making the calculation. Weekly data based on a Creditcards.com survey of 100 national card issuers found an average rate of 17.8 per cent at the end of July, another multi-decade high.
Card rates rose from long-term lows as the Fed gradually increased its benchmark interest rate between late 2015 and the end of last year. But card issuers pushed up rates faster than the Fed, with the result that the spread between the Fed benchmark and what card borrowers pay, at just under 15 per cent, has been wider only once: in the third quarter of 2009, with rates on the floor.
Analysts point to two groups that have contributed to the aggressive increase in rates by card-issuing banks: lawmakers and customers themselves.
The CARD Act of 2009, a US law designed to protect card holders from exploitation, put limits on banks’ ability to raise interest rates on existing balances. The card issuers “can’t reprice you once they sell you a card — so they have to price [more risks] in”, said John Hecht of Jefferies, a broker.
Another factor, he said, was that customers were not focused on what rates they would pay but instead on what perks, from cashback to airline miles, their cards brought.
“When you hear [bank] management teams talking about competition in cards, it doesn’t take place in terms of rates but in terms of rewards,” Mr Hecht said.
Since the crisis, card rates are often set by adding a premium to a fluctuating index — most often the prime rate, the lowest rate banks make available to non-bank customers. The prime rate in turn is directly related to the fed funds rate that is set by the Federal Reserve.
After the central bank’s decision to cut its benchmark last week, both JPMorgan and Citigroup, respectively the number one and two US card banks by loan volume, dropped their prime rates by a quarter of 1 per cent. This will flow through to the rates paid by many cardholders, at least initially. But card rates and prime rates do not move in tandem.
Brian Riley of Mercator, a research group, pointed out that since 2014, prime rates had risen by 1.25 percentage points, to an average of 5.5 per cent, while card rates were up 3.95 percentage points, more than three times as much.
Card companies have also found other ways to increase what card customers pay, for example by using annual fees, foreign transaction fees, and fees on balance transfers, according to Ted Rossman of Creditcards.com.
“I don’t think this [Fed] rate cut is a big gain to consumers with credit card debt — [their] rate is already high and even if it goes down slightly . . . [they] very well might end up paying higher fees in other areas,” said Mr Rossman.
For banks, the wide spread between the cost of money and what they can charge borrowers has made the card business especially profitable relative to other kinds of lending, especially given that default rates remain very low by historical standards. At JPMorgan, revenue from card lending rose 11 per cent, to $16.4bn, in 2018.
There is about $850bn in US credit card debt outstanding, according to the Fed. That is a record dollar amount, although as a proportion of gross domestic product, the figure had declined from 6 to 4 per cent over the past decade.*
Given the long duration of the current expansion, banks that expand too aggressively into card lending are taking a risk, said Brian Foran of Autonomous Research. “There is a lot of debate [in the industry] on whether now is the time to plant or to harvest,” he said. “You can push for growth with marketing, line size increases, [or] underwriting easing. But then if the dreaded recession actually hits next year, you are stuck with all the losses.”
*This article has been amended to correct figures for credit card debt as a proportion of GDP
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