A post at the CFPB blogsite indicated that the regulator would soon be reviewing the inner workings of the credit card industry, citing the $117 billion in interest and fees and the concentration of top issuers driving the business.
One of the issues cited was the increase in assessed interest, which increased by 20%, from 13.7% to 16.9% – certainly an issue, but hopefully the agency keeps an eye on risk. Yes, the credit card industry can be a money-maker. However, the general business model relies on issuers managing operational expenses, controlling loss rates between 3% and 4%, and growing organically.
Much of the success of a credit card business is driven by the economy. When employment is at high levels, losses are generally low. When employment deteriorates, so does the credit loss number. Our annual review of bank card profitability noted that the bankcard Return on Asset metric plummeted from 4.14% in 2019 to 2.40% in 2020, as issuers funded anticipated COVID-19 loss rates. Ironically, losses did not materialize as expected, but a shortfall in revolving debt caused interest revenue to drop in 2021. Top issuers could offset that revenue stream based on a seasonally adjusted basis of $1.09 trillion to $974.6 billion.
In the interim, credit card issuers loosened their credit standards to be more receptive to specific groups. For example, we cited a study by TransUnion, which indicated that the percentage of Gen-Z borrowers, those born after 1995, nearly doubled from 7.5% of total card originations to 14.2%.
The CFPB will not likely find lending fairness issues in reviewing the card business. Certainly, collection complaints, particularly by third-party agencies, is a regulator hotspot, but disclosures are clear, mainly due to the Schumer Box, standardized in 1989.
There’s no doubt that top issuers drive the market, but they also assume the highest risks. Remember $1 billion losses at top credit card issuers during the Great Recession? Top issuers also dominate other lending products, such as auto loans, mortgages, and student lending.
CFPB has a keen insight into credit cards, as you can tell from their 2021 review, where the newly confirmed Director, Rohit Chopra, reported:
Most measures of credit card availability decreased in 2020 after continued growth since the Great Recession. In addition, application volume for credit cards sharply reduced in 2020 from its peak in 2019, likely due to the interaction between reduced acquisition efforts by issuers and a decline in consumer demand.
Digital engagement is growing consistently across all age groups and nearly every platform type.
Many consumers received some form of relief on their credit card debts from their credit card providers during the pandemic. As a result, the Bureau estimates that over 25 million consumer credit card accounts representing approximately $68 billion in outstanding credit card debt entered relief programs in 2020, figures vastly higher than in prior years.
Expect little to be said about fair lending. FICO scores drive credit underwriting with a clinical view that levels the consumer lending playing field. Pricing may raise some eyebrows, but as the card industry tries to be more inclusive, it is only natural for interest rates to rise.
If I was I sitting at the CFPB throne, I’d look for better consumer education and literacy. Households need credit cards to transact and balance their budgets. Consumers need to understand early that paying off their credit cards is better than carrying balances. Sometimes, however, that is not practical. In an ideal world, credit card issuers make money on transactions, but when people need their transmission fixed on their car or have an urgent need, they find help through their credit card issuers. An effective credit card business relies more on transactions than consumers carrying debt that takes years to repay. When that happens, repayment risk escalates.
Interchange is a separate issue, often raised by merchants under the veil of public interest. Still, it seems every time a regulator reacts to interchange, the promise of reduced consumer prices goes unfulfilled. This gap proved out in price controls such as Australia, Europe, and the United Kingdom.
One of the good things about a regulatory audit is that it clears the path for credit card issuers to focus on their business. If price controls are what regulators require, expect credit to tighten. But most importantly, consider the current economic state. Things appear strong in credit today, but the risks are significant, as discussed in December 2021. Inflation is looming, interest rates are sure to rise, and unemployment and employee satisfaction are waning.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
