After two years of probing the GAO finally released its study on the U.S. Credit Card Industry, April 28. Their recommendation: don't regulate 'em just keep your eye on 'em.
Since the rate cap debate began two and half years ago VISA and MasterCard have sponsored dozens of academic studies and surveys to establish the competitive nature of the credit card business and the anti-consumer effect of rate regulation. However one major charge card competitor, American Express, has invested heavily in fanning the debate by releasing its own studies, consumer polls and sponsoring special bank bashing rallies with the support of national consumer groups like Bankcard Holders of America, Consumer Federation of America and the American Council on Consumer Awareness.
The new GAO study comes down smack in the middle of this debate. While recognizing the recent increase in pricing competition the GAO's message to bankers is: "There is a potential for tacit coordination [in setting credit card rates and fees] among large credit card issuers but the evidence is inconclusive." (Tacit coordination is the establishing, without an explicit agreement, a market price that resembles a formally negotiated price.) The message to commercial detractors and consumers groups is: wake up and smell the coffee, the credit card business has changed radically.
In the report's Executive Summary the GAO offers this explanation:
"Many industry analysts argue that differences between credit card and other types of lending explain why credit card interest rates were stable and industry earnings were high during the 1980s. Most significantly, credit card lending is riskier than most other lending activities because it is unsecured, and cardholders use their cards more when they are in financial distress. To remain profitable, card issuers must charge interest rates and generate earnings that compensate for the risks associated with credit card lending. Moreover, operating costs as a percentage of total lending costs are relatively high for credit card lending, while funding costs are relatively low. Because funding costs are relatively low, changes in funding costs were less influential in shaping credit card interest rates. During the 1980's, issuers may have built into credit card interest rates high "risk-premiums" as they extended credit to riskier customers.
Other explanations by economists suggest that the credit card industry was not under competitive pressures during the 1980s as a result of cardholder behavior. Several economists agree that cardholders have not traditionally shopped around for credit cards that offer lower interest rates. This has given credit card issuers incentives to maintain interest rate and earnings above levels that would prevail in a more competitive market. These economists argue that consumers do not respond to offers for cards with lower interest rates due to the costs associated with finding a new card and switching issuers. Cardholders with high credit card balances and low incomes may have found it particularly difficult to switch issuers.
Recent developments suggest competition is increasing among credit card issuers. According to many analysts, the slowing of growth of credit card lending and increased responsiveness by consumers to interest rates have caused issuers to work harder to maintain their market shares. In 1991 and 1992, several major issuers---such as Citibank--- offered credit cards with interest rates below 16 percent to cardholders with good credit histories. Moreover,large nonbank corporations---such as Ford, General Motors and General Electric---entered the industry, offered competitively priced cards, and attracted millions of customers. As a result, the numbers of cardholders with lower interest rate cards increased substantially. For example, the percentage of total credit card accounts subject to annual interest rates of 16.5 percent or less increased from 9 percent in 1990 to 39 percent in 1992.
GAO believes that these developments within the credit card industry should be closely monitored to determine whether the apparent increase in competitive performance is sustained. While many cardholders are clearly benefiting from lower interest rates, industry earnings remained relatively high throughout 1992 and 1993, due in part to record low funding costs. Also cardholders who represent higher default risks may not be offered the advantage of programs designed to lower their borrowing costs. Therefore, they may continue to pay interest rates exceeding 18 percent. Close monitoring is also warranted because the recent competition among issuers could lessen if congressional, media and public scrutiny of the industry's pricing practices subsides.
Currently the Federal Reserve collects and publishes information about credit card interest rates and other industry issues. However, GAO believes the Federal Reserve can provide additional information about available credit card interest rates. With such information, Congress and industry analysts can better monitor the recent price competition among issuers and assess whether it is sustained in the short or long term. Moreover, the Federal Reserve can comment on recent competitive developments in the industry in its annual report to Congress on credit card profitability."
The 64-page GAO report is available free of charge for the first copy and $2.00 for each additional copies. To order, write: U.S. General Accounting Office, P.O. Box 6015, Gaithersburg, Maryland 20884-6015.
Incidentally many of charts/tables/data appearing in the GAO report were based on data supplied by RAM Research Corporation. In addition to providing the information on a gratis basis, Robert B. McKinley, president of RAM Research Corporation, donated a substantial amount of time personally assisting the GAO.
If you examine a copy of GAO report please note the chart on page 43 needs to be updated with the following data. The 1993 figures were not available before the GAO report went to press. Also some prior year data was restated to reflect the revisions of some issuer data. The information below was also published in last month's CardTrak.
