Lesson learned: as the U.S. economy rebounded from the Great Recession, credit card lending was aggressive and consumers began to revolve again. In tandem with a variety of other policies, the economy is back to normal.
But, look at today’s news and see that politics is playing into the banking system again.
Bernie Sanders and freshman congresswoman Alexandra Ocasio-Cortez promise to introduce credit card rate caps of 15%, more than 250 basis points lower than the average lending rate today. The Washington Post reports.
- Under the new legislation, in addition to a 15% federal cap on interest rates, states could establish their own lower limits.
- The proposal is sure to meet stiff resistance from the banking industry which brought in $113 billion in interest and fees from credit cards last year, up 35% since 2012 according to S&P Global Market Intelligence.
Here is the issue. Credit card pricing and risk management work in tandem. Just about every credit card issuer relies on FICO scores to calibrate credit risk. Inherent in the pricing is a profit margin and an expectation of credit loss. Interest and fees drive the revenue. Think of a basic XY matrix: If the risk is X, then you need to charge Y to deliver the right return to your investors.
Now, if you cap the revenue side of the equation, then you need to limit your risk. In other words, if your credit policy strategy is only to book accounts with FICO Scores of 720 or better, then your rates can be lower than if you booked accounts with FICO Scores of 660. The 720 will perform with lower losses than the 660 group.
If you cap interest rates at say 18% (where credit unions are today), then you must tighten lending. Now, if you tighten lending, you reduce consumer spending. And then the recession cycle continues. Bernie may be positioning himself as a socialist Democrat, but life seems pretty good up in Burlington, VT as his income surged since the last election, according to Forbes.
No discussion about credit cards and politics would be complete without mentioning Elizabeth Warren, who has been recently creating politics about the U.S. Bankruptcy code and bailing out the student loan mess.
To bankers, put on your risk management hats. If interest rate margins are an issue; credit policies need to tighten. Costs need to the scrutinized, including the reliance on expensive credit card reward programs. Candidates have not brought up the interchange issue (yet), but is that a hold-card for November 2020?
Either way, politics will influence the credit card business in the United States but hope it treads lightly. Start slashing a portion of the $4 trillion placed on credit cards and you can expect another economic mess.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group