Credit Card Borrowing, Delinquency, and Personal Bankruptcy - Statistical Data Included

New England Economic Review, July-August, 2000 by Joanna Stavins

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Credit card delinquencies and personal bankruptcy rates increased during the mid 1990s, despite the strength of the U.S. economy. Even though per capita income rose during that period, household borrowing grew at an even faster pace. The ratio of consumer debt (excluding real estate) to disposable income increased, and it has remained above 20 percent, despite rising incomes. The rise in revolving debt--mainly credit card loans (1) -- was especially noticeable, resulting in an increase in the share of revolving debt in total consumer debt (Figure 1).

The increase in personal bankruptcy rates was also substantial. From 1994 to 1998, the number of nonbusiness bankruptcy filings in the United States increased faster than during the four-year period that included the 1991 recession (Figure 2), reaching more than one filing per 100 households in 1998. The good news is that the number of filings dropped in 1999, and in the first quarter of 2000 was 5.8 percent lower than a year earlier. (2)

The high rates of credit card delinquency and bankruptcy have generated much discussion about their causes. Some blame credit card default rates on lenders, whose more lenient standards have allowed consumers to borrow more than they can repay; others blame borrowers. The discussion has extended to the Congress, where a bankruptcy reform bill has been debated for the past few years. This article examines the relationship between consumer credit card borrowing, delinquency rates, and personal bankruptcies. It looks at developments involving borrowers, the demand side, and lenders, the supply side.

Section I of the article presents background information and summarizes previous literature showing that credit card loans have been extended to higher-risk consumers over time. Section II analyzes borrowers' or the demand side of the credit card market. Using data collected in the 1998 Survey of Consumer Finances, we examine the effect of credit card borrowing on consumer payments delinquency. We also examine the relationship between credit card debt and the increase in bankruptcy rates. On average, households that had filed for bankruptcy in the past carried higher unpaid credit card balances and had significantly higher ratios of credit card debt to income than those that had not filed. People who had filed for bankruptcy in the past were also more likely to default on their payments, even after controlling for their income and credit card debt. Regions with higher credit card debt relative to income were more likely to have higher rates of bankruptcy filing.

Section III shifts to the analysis of lenders, to examine the supply side of the credit card market. Many blame lenders for the increase in credit card default rates, as they extend credit to higher-risk individuals. Their liberal lending standards may have induced cardholders to borrow more than they could afford, raising default rates. While lenders may be able to compensate for higher default rates by charging higher interest rates and fees, Ausubel (1999) found that banks face adverse selection--consumers who accept worse credit card offers are more likely to default on their credit card loans and to file for bankruptcy. If that is the case, then lenders that offer worse "packages" of interest rates and fees on credit card plans would have higher delinquency and charge-off rates and potentially lower net revenues from credit cards than those that offer more attractive packages.

Using detailed panel data on individual credit card issuers in the United States between 1990 and 1999, we test whether credit card lenders face an adverse selection problem, whereby banks making worse credit card offers attract more risky customers and have higher delinquency and charge-off rates than others. We find that banks that charge higher interest rates and some fees have higher delinquency rates (the fraction of outstanding credit card loans that is at least 60 days overdue), but not higher charge-off rates (the fraction of outstanding credit card loans that is written off as losses). Moreover, banks that charge higher interest rates were found to have higher net revenues from credit card lending than other issuers. Thus, despite the adverse selection the lenders face, extending credit to riskier individuals may still be profitable, at least in the period of good times considered here. The article concludes with a brief discussion of the recently debated bankruptcy reform.

I. Background

Credit cards have become a common form of payment. Average balances have increased and use of credit cards is more widespread across income groups (Yoo 1998). Figure 1 shows that outstanding credit card loans increased steeply during the mid 1990s. Based on data from Surveys of Consumer Finances, Evans and Schmalensee (1999) show that credit cards have become more common over time: Between 1970 and 1995, the fraction of households with at least one credit card rose from 16 percent to 65 percent, the average ratio of credit card charges to income increased from 4 percent to 16 percent, and the average amount owed on a credit card went up fourfold, in 1995 dollars.