Credit-card Crackdown Can Only Generate Limited Rewards
Jun 23, 2023
Each American has a minimum of two open accounts, making credit cards essentially a member of the family. They can also bring happiness and misery, just like any member of the family. It sounds like a smart vote-winner for President Joe Biden's administration to push for a reduction in the late payment penalties that borrowers must pay. Such direct action is likely to have little effect in reality.
Credit cards are meant to make spending simpler, but in reality, they are just as complicated as the riskiest financial derivatives. Customers who have a balance at the close of the month must pay exorbitant interest on it, and penalties may apply if they don't pay on time. If many payments are missed, certain cards recalculate their rates to be higher and more severe. The small print can be confusing; according to a Bankrate survey, over 40% of US people who carry credit card bills on a month-to-month basis are unaware of their interest rate. The opacity is demonstrated by the overwhelming profitability of credit card lending, which can provide 20% or higher returns on equity for institutions like JPMorgan and Capital One.
High fees and large profits partially reflect the unsecured nature of credit card financing. If the client stops paying, there is no house or car to seize. However, the expensive terms and the product's widespread use make it an easy target. In support of Biden's campaign to eliminate what he refers to as "junk fees," the Consumer Financial Protection Bureau has suggested reducing late costs at $8, less than one-third of their present amount. Banks are permitted to charge higher, but only when it is necessary.
It's difficult to refute the claim that people with less financial sophistication are disproportionately punished by late fines. Beyond it, fake accuracy is widespread. The CFPB's $8 threshold is based on estimates that the banking sector claims are flawed; the agency claims that banks failed to offer more accurate data when given the chance. The real price, according to the American Bankers Association, is more like $46. The United Kingdom established a fair amount that is roughly twice as high as the CFPB's over twenty years ago.
Banks worry that a fee that is too low won't prevent customers, but this is a difficult statement to make. Some cards like Citigroup and Goldman Sachs already come without late fees. There are further strategies to discourage tardiness, such as informing clients that tardiness would negatively impact their credit ratings.
Mathematics and logic are unlikely to protect banks from government intervention. Unpopular late fees are smack in the political crosshairs. Furthermore, the CFPB is unique among financial regulators in that it has a director, Rohit Chopra, a Democrat nominated to the position. The Securities and Exchange Commission or the Federal Reserve, for example, put issues to a vote and publish dissenting views. The campaign makes sense if Biden wants to project the image of a man of action.
In terms of money, it's less cut and dry. A reduction in late fees would, on the one hand, result in a reduction in revenue for card issuers including JPMorgan, Capital One, Discover Financial Services, and Bank of America. A little under $2 billion, or about 5%, of Capital One's annual revenue, comes from late fees. If everything else remained the same, a two-thirds reduction in that income would result in a 15% decrease in pre-tax profit for the business. Banks, on the other hand, have many levers at their disposal.
Banks have informed the CFPB that if fees are limited, they will either raise other costs or reduce lending to people who need it the most. The CFPB proposal's supporters claim that this is all empty rhetoric. Although regulations put in place in 2010 limited card issuers' ability to raise rates and fees, they still have a lot of flexibility. Lessons from history are likewise unclear. Following the 2008 financial crisis, major credit-card rulemaking underwent its most recent iteration. Cutting fees was likely to cause other rates and fees to increase.
