US credit card holders are currently paying the highest interest rates on their credit card balance over the last quarter-century. Additionally, the efforts and rate cuts made by the Federal Reserve might not bring much relief.
According to FED Data, on interest-bearing card accounts, the average rate has topped 17 percent in May, the highest rate that the central bank has ever seen over the last 25 years. By analyzing the weekly data on 100 national card issuers, we come across another multi-decade high – an average rate of 17.8 percent at the end of July.
As the Federal Reserve had been gradually increasing its benchmark interest rate, credit card rates have risen substantially from long-term lows. But because most credit card issuers pushed their rates up faster than the Fed, the end result was that the difference between what card borrowers pay and the Fed benchmark has been wider only once – when rates hit the floor in the third quarter of 2009.
When asked about the culprits behind this aggressive increase in rates by card-issuing banks, the analysts point at two groups: the lawmakers and the customers themselves.
In 2009, a US law was designed to put limits on the banks’ ability to raise interest rates on preexisting balances and to protect credit card holders from exploitation. According to broker John Hecht of Jefferies, this law, known as the CARD Act of 2009, does not allow credit card issuers to “reprice you once they sell you a card — so they have to consider the risks”. He adds that another contributing factor is that instead of focusing on the rates that they will pay, customers would prefer to focus on the perks, airline miles, and cashback that their cards brought. Mr. Hecht also says that “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,”
Ever since the crisis, credit card rates are usually set by adding a premium to a fluctuating index, which is usually the lowest rate that banks can offer to non-bank customers, also known as the prime rate. In turn, the prime rate is connected to the fed funds rate set by the Fed.
After the decision was taken last week by the central bank in regards to benchmark cutting, Citigroup and JPMorgan, the most important US card banks by loan volume, decided to drop their prime rates by 0.25 percent. At least initially, this change will affect the rates paid by cardholders. But prime rates and card rates don’t necessarily need to move in tandem. As Mercator’s Brian Riley pointed out, in 2014, the card rates were up 3.95 percentage points, while the prime rates had only risen by 1.25 percent reaching an average of 5.5 percent.
Additionally, credit card companies have found other ways to increase the rates paid by cardholders by implementing or raising the fees for foreign transactions, annual fees, and balance transfers. Ted Rossman, finance specialists, admits that he doesn’t think that the Fed rate cuts will be advantageous for the consumers, as they are already paying high rates and they might end up paying higher fees for other services.
For card-issuing banks, the wide gap between what they can charge borrowers and the cost of money is making the credit card business extremely profitable. Other types of money lending have become less profitable especially because the default rates are very low by historical standards.
At JPMorgan, for instance, card lending revenue in 2018 has risen to 11 percent, reaching a whopping $16.4bn. In the United States, there is about $850bn in credit card debt which, according to the Federal Reserve, is outstanding. We are dealing with a record amount of debt, although, over the past decade, the figure has declined from 6 to 4 percent.
Given that the current expansion is taking a long time, a lot of banks have expanded aggressively into card lending, thus, taking a great risk. According to Autonomous Research’s Brian Foran “There is a lot of debate [in the industry] on whether now is the time to plant or to harvest,” and he adds that “You can push for growth with marketing, line size increases, underwriting easing. But then if the dreaded recession actually hits next year, you are stuck with all the losses.”