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Cardholders pay near-record markup on interest rates

Fred Williams

“Treasury wants credit card rate probe,” the headline blared.

Lawmakers are demanding to know why card rates are stubbornly high, the article said, when banks’ cost of funds are at historic lows.

The article appeared in “Perth Now.” The lawmakers are in Australia, where cardholders are paying a record markup over banks’ cost of funds.

But while the controversy is on the other side of the planet, rates in the U.S. look similar. Here’s a chart from the Australia Broadcasting Corp.:

aus rates

Used with permission of Australia Broadcasting Corp.,
based on data from the Reserve Bank of Australia


And a chart of comparable rates in the U.S., drawn from the
U.S. Federal Reserve’s database:

ff v bankcard rates


The charts use different terminology, but both illustrate the markup that banks charge credit card users. The bottom line, called “cash rate” in Australia and “federal funds rate” in the U.S., shows banks’ cost of short-term funds. The upper line shows the average rate charged on credit cards. The gap between the lines shows the markup that cardholders pay. Since about 2008, the gap has grown wider in both nations.

In short, banks are charging a near-record markup on credit cards, even as rates they’re paying for funds are at historic lows. It’s happening in Australia, and in the United States. But there, it’s causing controversy, here, it’s not.

For most of the period since 1994, the markup on card rates in the U.S. hovered around 10 percentage points. Then in late 2007 the Fed began cutting rates — and banks did not follow suit. As a result, the rate they collect on cards grew, relative to their cost of funds.

According to the Federal Reserve, the average card interest rate was 13.5% in February. The same month, the effective federal funds rate was practically 0 percent, at about one-tenth of 1 percent. That means the markup on card rates is 13.4 percentage points. The record since 2004, when the data series starts, was 14.7 points, set in 2009.

In the recession, cards were taking heavy losses from defaults. But these days, default rates are hovering around historic lows. So why should card rates be sticking at relatively high levels?

Not because of profiteering, bankers say.

“Credit cards are a highly competitive market,” said Rob Strand, senior economist at the American Bankers Association. “There are so many providers out there, there’s no way banks will get away with providing uncompetitive rates.”

Rather, he said, new legislative costs help explain the gap. At about the same time the Fed was cutting rates, the Dodd-Frank Act increased banks’ capital requirements and business costs. Strand also said the federal funds rate is not as good a measure of banks’ costs as the rates on one-year Treasuries. But banks link their variable credit card rates to the prime rate, which moves in step with the federal funds rate.

Not all economists are convinced that competition keeps card rates down. This isn’t the first time card APRs were “sticky” as other rates declined. In the period between 1989 and 1991, market interest rates dropped about 4 points, while “bank credit card rates barely moved,” economists Paul S. Calem and Loreta J. Mester wrote in The American Economic Review. The pattern repeated earlier episodes of rate stickiness in the 1980s, they said. While there are numerous banks handing out cards, they nevertheless seem able to keep from cutting prices when market rates go down.

One researcher went so far as to call it a “failure of competition in the credit card market.” Card rates are slow to fall at least partly because consumers don’t take into account the odds that they’ll actually wind up paying the interest rate on the card, economist Lawrence M. Ausubel wrote in a 1991 paper.

Peeved at the high markup, the Senate in 1991 passed a measure that would have capped credit card interest rates at 14 percent. “It is obvious that the marketplace is not working,” Sen. Charles Schumer said in a committee hearing. Although the measure didn’t make it through the House, it stirred up a debate about bank profits.

Where’s the outcry in 2015 — besides Australia?

These days, consumer advocates are focusing on payday lenders, where loan rates frequently top 300 percent. For consumers, the Credit CARD Act of 2009 was a victory, practically doing away with costly over-limit fees and stopping surprise rate hikes. Charging higher rates up front is preferable to snaring cardholders with surprise costs, consumer advocates have said. At least you know beforehand what you’ll pay. Assuming, that is, you’re not blinded to the rate on your card by visions of the rewards you’ll get for adding to the balance.

And market rates can’t stay near zero forever. When the federal funds rate finally begins to return to normal, perhaps in September, credit card rates will come unstuck. Unfortunately for cardholders, they’ll move even higher.

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