There has been some chatter, nicely summed up on the cover of today’s New York Times, that if Congress legislates new regulations for credit-card companies (the Senate is due to vote on a bill today), conscientious customers who pay their balances off every month will suffer. The idea is that if we deny card companies the ability to retroactively hike interest rates on account holders irrespective of whether or not they’ve been paying the minimum required amount on time, the foundation of credit-card company profitability will start to shake. Annual fees—which have largely disappeared in recent years—will come rushing back in, and all those perks like airline miles and $25 gift cards to Barnes & Noble will go away.
I am dubious. Not that I’d have a big problem with a change in the status quo. I pay my credit-card balance off every month (yeah, I know, good for me), which means I get a very valuable service—an easy way to buy things on-line and when I don’t have cash on me—at absolutely no cost. I benefit from that, but it does disrupt my sense of fairness. So, fine, assess an annual fee. The only reason I don’t currently pay one is because a couple of decades ago a marketing war over “no annual fee” cards erupted and now all card issuers pretty much have to keep up.
But like I said, I don’t think it’s going to come to that. Why? Because there’s a difference between me not paying to have a credit card and the credit-card company not getting paid. (Did you pay to read this blog post? No. Yet somehow I’m getting paid to write it.)
Every time I buy something with my credit card, the store I buy it from pays an interchange fee to—in my case—Citigroup (via Mastercard). This makes perfect sense. There is a value to the store in accepting credit cards; I am more likely to shop there. Interchange fees tend to run about 2% to 3% of what you spend. That might seem like a hefty cut. In fact, businesses really complain about how high interchange fees have become. It doesn’t look like that’s changing anytime soon, though.
How valuable are interchange fees—and, by extension, customers who don’t funnel card companies money by carrying balances month-to-month? Well, according to a 2006 report from the U.S. Government Accountability Office, for every $100 in credit-card balances outstanding, card companies make $10.45 in profit from interest and $2.87 in revenue from interchange fees. Yes, interest accounts for a bigger slice. But there’s a risk that comes from that revenue stream—card companies never know when balance-carrying customers will stop paying their bills. That’s hardly a minor issue: default rates at many card companies are approaching 10%. Interchange fees, by comparison, are essentially risk-free.
Another interesting comparison from the GAO report: revenue from penalty fees accounts for $1.40 for every $100 charged—half of what the firms make from people simply using their credit cards. The next time someone tries to tell you that legislating a fairer system for assessing penalty fees will make card companies stick it to their good customers, you might bring that up.
Now, it is possible that at $2.87 for every $100 charged, I’m not a profitable customer. It is possible that Citi has extended me credit in the hopes that some day, some glorious day, I’ll rack up $8,000 in charges and then spend years to pay them off. But again, I’m dubious. I’ve been with Citi for a long time. They’re pretty used to my spending—and bill-paying—habits. If they were losing so much money on me, why would they send me a new credit card, under the same terms, when my old one expired? More to the point, why would credit-card companies, in the aggregate, do business with the 42% of American households that pay off their balance each month?
One more thing. The article in the Times, which really did feel like a spoon-feed from the American Bankers Association, raised the spectre of card companies starting to charge interest on purchases same-day. In other words, no more 30-day grace period. My gut on this is that it’s just passed-along fear mongering. People who pay off their balances in full each month don’t have credit cards because they want to borrow money, but because cards make transactions easier. If card companies start charging these folks financing charges, how quickly do you think they’ll all switch to debit cards? My guess is weeks, not months.
I know I would. And I’d take my interchange fees with me. Of course, that would simply reshuffle the money from Citigroup to J.P. Morgan Chase. There’s no net difference in terms of the money the banking industry as a whole collects. Still, I’m pretty sure Citi would have an interest in not letting that happen.