The answer is not simple because consumers today are well informed and less loyal than ever before. You simply cannot raise prices across the board unless you want to blow your legs off.
Part of the solution lies in matching pricing to credit risk. The last wave of re-pricing got underway in 1992 with the switchover to variable interest rates. Since that time the percentage of variable interest rate cards in the U.S. has soared from 33% to 81%. Several major issuers also phased-in tiered interest rates pegged to credit risk. It was called by some the "good, okay and shaky" or "three tier" strategy. The "okay" consumers (most) got the core or primary interest rate set by the issuer. The "good" cardholders earned an interest rate 200 to 300 basis points under the core rate and the "shaky" cardholders were charged a rate at least 200 basis points above the core rate.
Prior to 1992 the card industry was basically a one-size-fits-all market -- one fixed interest rate and one annual fee. Some issuers did, however, offer different pricing on standard cards and gold cards. However the entry of new deep- pocketed, co-branding partners, a maturing market for issuance, and rising consumer price sensitivity, forced the card industry to become intensively competitive. Thus the move to risk-based, variable interest rate, no-annual-fee pricing.
This type of pricing served the industry and consumers well through 1995. However last summer delinquencies began to rise and continued rising through this summer. Consumers were on a credit card binge in 1994 and 1995 spending and racking up debt at annual growth rate of about 25%. The card industry offered more places to use plastic (supermarkets, doctor offices, insurance premiums, etc.) and more incentives to use plastic (air miles, cash back, free gas, free videos, etc.). And the pricing driven by competition, and tempered by risk, was a boon for consumers.
Some issuers, in the quest for growth, reached out to higher risk segments of the marketplace during this boom period. Low income, the highly indebted, the very young and the very old were showered with credit card offers.
Like the stock market there is always a correction lurking in the future. The bank card industry is now in a correction. The pricing structures and risk assessment policies phased-in since 1992 no longer work.
The card industry must move risk-based pricing to another level, offering a wider range of pricing based on a cardholder's creditworthiness. Three levels are not good enough today. Card issuers need a dozen or more pricing tiers. Better yet: take risk-based pricing to the extreme by setting a core rate and multiplying it by an applicant's credit score to offer truly "individualized" card pricing. After establishing the account review the cardholders creditworthiness periodically, appropriately adjusting pricing.
While this approach makes sense (and hopefully cents) in today's market there is a downside. How do you sufficiently disclose this type of pricing ? How do review an applicants credit history without creating a potentially derogatory credit file inquiry for the applicant ? Once the account is opened, How do you make pricing adjustments, based on a deteriorating credit score, acceptable and tolerable to a cardholder ?
There are no easy answers. Issuers adopting this pricing strategy will have to take the fuzziness out of this type of pricing. Simply stating the pricing will be "based on an applicant's credit history" does not go far enough. A realistic pricing range needs to be disclosed, not a broad range like 9% to 29%. Card issuers also need to expand disclosure on all card pricing terms including the interest rate for cash advances; how late fees, overlimit and other fees are assessed; how interest is calculated -- daily or monthly; and the basis for changing pricing on an open account. Better yet card issuers should offer the actual cardholder agreement to any potential applicant upon request.
To date, the card industry, as a whole, has done a poor job with the disclosure of credit card terms. Current disclosure regulations have not kept pace with this rapidly changing marketplace and as a result consumers have entered a fog when it comes to how credit card costs are assessed. In order for the migration to a segment-of-one pricing to work card issuers need to do a much better job of making consumers comfortable with the offer. Ways to assess creditworthiness without inflicting damage to an applicant's credit file need to be worked out.
What else can card issuers do to navigate through this changing marketplace ?
Work with, not against, over-extended cardholders. Also avoid harassing profitable cardholders with unnecessary penalties.
Since early 1995 several major card issuers have implemented punitive interest rates on chronic late payers. In some cases the difference between the core rate and punitive rate is 10% or 1000 basis points.
Chronic late payers are divided into two categories: cardholders struggling with debt and cardholders with poor bill management. However punitive interest rate policies generally do not discriminate between the two.
Over-extended cardholders, struggling with debt, only sink further when scorched with an excessive high interest rate and late payment or over-limit fees. With the bankruptcy stigma vanishing across the U.S., cardholders finding themselves in a financially disastrous situation will see punitive rates and other nuisance fees as an incentive to seek relief. The solution is to work with these cardholders to avoid a bankruptcy and a charge-off, not provoke it. Card issuers need to lower interest rates, waive penalty fees and hold or reduce the credit line for such cardholders. This flies in the face of conventional banking wisdom, but these are unconventional times.
Forgetful, but financially healthy cardholders, making occasional late payments do not represent a threat to profitability. As a matter of fact this is the exactly the passive type of cardholder most issuers dream about, those paying little attention as the interest clock keeps running. Offering an automatic minimum payment option is just what the doctor ordered for this group. This will avoid a technical default for the cardholder and will maintain a high yielding account. Sometimes bankers cannot see past the numbers.
The credit card industry is evolving quickly . . . there is no status quo. The gravy train will run again as long as issuers evolve with cardholders. The problem right now is too many issuers are laying new tracks.
