Report to the Congress on the Profitability of Credit
Card Operations of Depository Institutions
- Recent Trends in Credit Card Pricing
- Recent Regulatory and Legislative Actions
Recent Trends in Credit Card Pricing
Aside from questions about the profitability of credit card operations, considerable attention has been focused on credit card pricing and how it has changed in recent years. Analysis of the trends in credit card pricing in this report focuses on credit card interest rates because they are the most important component of the pricing of credit card services. Credit card pricing, however, involves other elements, including annual fees, fees for cash advances and balance transfers, rebates, minimum finance charges, over the limit fees, and late payment charges.1 In addition, the length of the "interest free" grace period, if any, can have an important influence on the amount of interest consumers pay when they use credit cards to generate revolving credit.
Over time, pricing practices in the credit card market have changed significantly. Today card issuers offer a broad range of card plans with differing rates depending on credit risk and consumer usage patterns. Moreover, most issuers have moved to variable rate pricing that ties movements in their interest rates to a specified index such as the prime rate.
As noted, risk-based pricing has become a central element of most credit card plan pricing regimes and the current downturn and new credit card rules spurred changes in pricing in 2009 and 2010. In most plans, an issuer establishes a rate of interest for customers of a given risk profile; if the consumer borrows and pays within the terms of the plan, that rate applies. If the borrower fails to meet the plan requirements, for example, the borrower pays late or goes over their credit limit, the issuer may reprice the account reflecting the higher credit risk revealed by the new behavior. Regulations that became effective in February 2010 limit the ability of card issuers to reprice outstanding balances for cardholders that have not fallen at least 60 days behind on the payments on their accounts. Issuers may, however, reprice outstanding balances if they were extended under a variable-rate plan and the underlying index used to establish the rate of interest (such as the prime rate) changes. The new rules continue to provide issuers with considerable pricing flexibility regarding new balances.
At present, the Federal Reserve collects information on credit card pricing through two surveys of credit card issuers. Because of the significant changes in the pricing of credit card services, the Federal Reserve initiated the Quarterly Report of Credit Card Interest Rates (FR 2835a) at the end of 1994. This survey collects information from a sample of credit card issuers on (1) the average nominal interest rate and (2) the average computed interest rate. The former is the simple average interest rate posted across all accounts; the latter is the average interest rate paid by those cardholders that incur finance charges. These two measures can differ because some cardholders are convenience users who pay off their balances during the interest free grace period and therefore do not typically incur finance charges. Together, these two interest rate series provide a measure of credit card pricing. The data are made available to the public each quarter in the Federal Reserve Statistical Release G.19 Consumer Credit. The Federal Reserve also collects detailed information on the pricing features of the largest credit card plan of a sample of issuers through the Survey of Terms of Credit Card Plans (FR 2572)2.
Because information from the FR 2835a survey does not have an extended historical interest rate series for comparison purposes, this report also presents data from the survey that preceded and was replaced by the FR 2835a, the Federal Reserve's Quarterly Report of Interest Rates on Selected Direct Consumer Installment Loans (FR 2835). Data from the FR 2835 indicate that credit card interest rates fell sharply from mid 1991 through early 1994 after being relatively stable for most of the previous twenty years, and fell again over the 1998-2003 period (Table 2).3 Since early 1998, credit card interest rates have fluctuated between 12.78 and 15.85 percent.
It is important to note that while average rates paid by consumers have moved in a relatively narrow band over the past several years, interest rates charged vary considerably across credit card plans and borrowers reflecting the various features of the plans and the risk profile of the card holders served. For 2011, credit card interest rates averaged 13.09 percent for those incurring finance charges, down from 14.26 percent in 2010.4 It is important to note that as the recession emerged, spreads between issuers' cost of funds and prices charged on credit cards widened substantially, and have remained at elevated levels since then.
Table 2. Average most common interest rate on credit card plans, 1974-August 1994, and the interest rate assessed on accounts incurring interest charges, November 1994-2010 (Percent)
Note: Prior to November 1994 interest rates were those reported in the Quarterly Report of Interest Rates on Selected Direct Installment Loans. Beginning in November 1994 interest rates are those reported on the Quarterly Report of Credit Card Interest Rates for those credit card holders incurring interest charges.
Source: Board of Governors of the Federal Reserve System.
Additional evidence on changes in credit card interest rates comes from the FR 2572. Although not precisely comparable from period-to-period because of changes in the sample of reporters, this statistical series reveals a general decline in credit card interest rates in recent years. For example, only 11 percent of the respondents reported interest rates below 16 percent on their largest credit card plan as of September 1991, but 80 percent did so as of January 2012 (the most recent report available). In addition, the proportion of card issuers reporting that they utilize variable rate pricing has also increased substantially since September 1991. As of September 1991, 23 percent of issuers used variable rate pricing; as of January 2012, the proportion was 72 percent.
1. In June 1996, the Supreme Court ruled that states may not regulate the fees charged by out-of-state credit card issuers. States have not been permitted to regulate the interest rates out-of-state banks charge. In making its decision, the Court supported the position previously adopted by the Comptroller of the Currency that a wide variety of bank charges, such as late fees, membership fees, and over-the-limit fees, are to be considered interest payments for this purpose. This ruling will likely ensure that banks will continue to price credit cards in multidimensional ways rather than pricing exclusively through interest rates. Source: Valerie Block, ASupreme Court Upholds Nationwide Card Charges, American Banker, June 4, 1996.
An assessment of the fees charged by credit card issuers is provided in "Credit Cards: Increased complexity in Rates and Fees Heightens Need for More Effective Disclosures to Consumers," U.S. Government Accountability Office, Report 06-929, September 12, 2006. Refer to www.gao.gov. Return to text
2. The information in the FR 2572 survey is published twice a year by the Federal Reserve. Historically, the data were made available in a statistical release, the E.5 A Report of the Terms of Credit Card Plans. Beginning in 1995, the E.5 statistical release was discontinued and data are now available exclusively on the Board's web site at www.federalreserve.gov/creditcard/survey.html. Return to text
3. For a comprehensive discussion of the factors that account for the levels and changes in credit card interest rates, see Glenn B. Canner and Charles A. Luckett, ADevelopments in the Pricing of Credit Card Services; also U.S. General Accountability Office, U.S. Credit Card Industry (GAO/GGD-94-23, 1994). Return to text
4. It should be emphasized that the interest rates reported after August 1994 are based on the new survey and are not strictly comparable to the interest rates reported on the older survey. Return to text