The bank credit card model works well across the world, but repayment terms are not the same everywhere. Many markets such as Canada, the United Kingdom, and the United States use standardized formulas to calculate the minimum payment due each month. Using a model of 1/36ths of the balance, it comes out to about 3%. The goal is to require that the account does not have negative amortization and that the standard payment reduces the debt by 1% to 2% each month.
The negative amortization standard is necessary because when the account is structured to allow that, the interest paid will be less than the interest earned. This will result in something referred to as “perma-debt.” Consumers do not want perma-debt, bankers avoid it, and regulators hate it.
Other minimum due strategies, set by regulations and societal norms, require a shorter payment term, such as Turkey, which compresses the minimum due to about 1/12th for certain spend categories, or the Sharia-compliant model, which forbids the assessment of interest and relies on a fee for the outstanding credit line, which addresses a global market of nearly 1.8 billion Muslims.
The new model offered in Australia was announced by a test run by National Australia Bank (NAB), a top credit card issuer in that country. The Australian Financial Review calls the new offering a defensive play against emerging lenders who offer buy-now-pay-later (BNPL) products. Headlines across the globe note that the card does not charge interest. Instead, it charges fees similar to the Sharia-compliant model.
- NAB’s StraightUp card will never charge interest to the customer, in contrast to the 20 percent rates on many credit cards. Users will instead be required to pay a minimum amount each month (depending on the card’s credit limit), including a monthly fee. There are no late fees and no fees if the card is not used.
- NAB says the new Visa card is a response to the same driver that propelled the growth of Afterpay: Millennial customers wanting to reduce their use of interest-bearing cards, so debts don’t spiral out of control.
It is important to note that no interest does not mean free credit. Banks can’t operate in that environment. Some costs and risks must be funded.
- For a $1000 credit limit, customers will be required to pay $35 a month towards the balance, including a $10 monthly fee. For a $2000 limit, the monthly minimum repayment will be $75, including a $15 monthly fee; At a $3000 limit, the repayment is $110 per month, including a $20 fee. Customers are required to pay the minimum payment, or the card may be blocked. There are no rewards attached to transactions.
The driver for the change is growth in installment loans. Some issuers worry about the cannibalization of credit card volume.
- The new model could put pressure on other issuers, including Citi, Latitude, and Macquarie, to experiment with their offerings. It arrives after Commonwealth Bank moved into the buy now, pay later space with an investment in Klarna and the integration into its bank application. It is another example of growing competition in payment options after PayPal entered the installment market.
- The Reserve Bank this week reported a 10 percent decline in the number of credit cards on the issue over the 12 months to the end of July and a 14 percent fall in the value of transactions. Analysis of the RBA data by consultancy McLean Roche found the number of credit cards dropped by 2 million over the past year, and Australian consumers have canceled 5.3 million cards since mid-2017.
It is unlikely that NAB’s model will change the world, but it will force other bank card issuers to look at their business models, as Finextra reports on a next-day launch by competitor Commonwealth Bank:
- Not to be outdone, NAB rival CBA whipped out its plans to launch an equivalent card – CommBank Neo – in late 2020, and a no-interest card for business customers in early 2021. Like the NAB card, CommBank Neo will come with three pre-set credit limits and a slightly elevated monthly fee of between $12-$22. The T&Cs call for a minimum repayment of $25 or 2 percent of the closing balance, whichever is greater.
The new offer will be interesting to watch. Although credit lines are relatively low, typically south of $3,000, it may hit a chord with new card accounts and work as a countermeasure against fintech installment loans.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group