The Availability and Profitability of Credit Cards

Credit cards serve a dual purpose in our economy. First, they are used to pay for things in lieu of cash or checks. Used in this way, they make it easier for people to conduct day-to-day transactions and manage their cash. At the same time, credit cards are often used for short- or medium-term unsecured borrowing. Individuals may use the revolving balance of a credit card to finance large purchases.

Credit cards often carry substantially higher interest rates than, say, mortgages and auto loans, because credit cards are not secured by marketable assets and they have uncertain repayment periods. Interest rates for credit cards can also serve as a barometer for the broader risk profile of consumers as well as the availability of credit to them. Following a peak at 14 percent in the first quarter of 2010, credit card interest rates have fallen over the past two years. When interpreted jointly with the increasing balances, this development suggests that credit is becoming more available to consumers.

Credit has been growing, while at the same time, lenders’ credit card portfolios have been getting healthier. Charge-offs were particularly problematic during the last recession, when they crept steadily upward to hover around 10 percent for almost a year. However, they started a determined decline in the second quarter of 2010, a trend which in turn led to a choppy but unmistakable rebound in credit card issuers’ profit (as measured by the excess spread rate).

Another factor that affects the availability and cost of unsecured credit is liquidity in the market for credit card debt. Historically, the asset-backed securities (ABS) markets have funded a substantial share of consumer credit loans. In the fall of 2008, both the market for short-term bank funds and the market for securitized credit card receivables seized up, meaning banks could only fund new credit card debt on their balance sheets. A visible result was that for the five months between September 2008 and March 2009, no ABS secured by credit card receivables were issued, as spreads on existing securities spiked from around 1 percent to nearly 7 percent. In many cases, financial institutions chose to severely restrict the amount of new credit extended. Balance sheet funding by commercial banks continues to be the most widely observed form of credit card lending even today. The total amount of outstanding credit card debt held at commercial banks is holding relatively steady at around $600 billion.

While the virtual disappearance of an important funding source could be a cause for concern, if balance sheet lending leads to more responsible lending and sound banking, credit market excesses of the bubble years may be less likely to recur.