Credit-card rates reflect our economic problem, not the solution
If credit-card rates are at a 12-year peak but card usage is at record levels, why do we think interest rates are a tool for controlling the economy and inflation? Consumers appear insensitive to rates.
The Bank of England cut its interest rates to a record low of 0.5 per cent after the credit crunch to stimulate an economy brought to its knees by too much borrowing. Yet the credit card suppliers have responded by increasing their average rates to 18.8 per cent, the highest for 12 years.
That might look like profiteering, but the 2009 results from Barclaycard show its profits falling 4 per cent to £761m despite its income increasing 26 per cent.
Reconciling a wider interest margin with lower profits requires the recognition of risk. Barclaycard’s impairments – bad debts in layman’s language – rose by a whopping 64 per cent and they were not insignificant to start with.
The fact is that credit-card lending is the riskiest end of the banking business. Despite rejecting about a third of card applications, lending is largely done on self-certification and crude credit-scoring. The loans are not necessarily covered by assets or income and by the time borrowers cannot repay their credit card, they have already exhausted all their other financial resources.
So that massive spread between the banks’ borrowing and card-lending rates covers a lot of write-offs by bad customers that have to be paid by the good cardholders. That’s why the best customers – half the turnover – avoid high interest rates altogether by paying off their balances before interest starts ticking in. To these people, credit cards are not the expensive evil denounced by consumer groups but a very convenient cost-free method of payment.
But that means one medium-size group of people paying high interest rates is supporting the large group of good clients not paying them at all, plus the small group of bad clients not paying either interest or capital. This middle group is either insensitive to interest rates – which undermines the basis of which monetary policy is based – or desperate for credit. You only have a permanent credit-card balance if you have been refused additional finance everywhere else.
There are two signs of economic recovery that we should watch out for. One is the Bank of England raising bank rate because it thinks growth sufficiently strong to be sustainable without stimulation, the other is credit-card companies cutting their rates because better employment prospects reduce the rate of defaults. That is the opposite of the situation we are in now.
