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

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

We tested whether worse credit card packages lead to higher net revenues from interest rates and fees to the issuing banks. The following reduced-form equation was estimated:

revenue = [[lambda].sub.0] [[lambda].sub.1] deposits [[lambda].sub.2] APR [[lambda].sub.3] fee

[[lambda].sub.4] grace [[lambda].sub.5] minfin [[lambda].sub.6] cash [[lambda].sub.7] late

[[lambda].sub.8] over [[lambda].sub.9] rebate [[lambda].sub.10] warrant

[[lambda].sub.11] protect [[lambda].sub.12] accid [[lambda].sub.13] tradisc

[[lambda].sub.14] auto [[lambda].sub.15] buydisc [[lambda].sub.16] regis

[[lambda].sub.17] other [[lambda].sub.18] time v (4)

where:

revenue is the bank's quarterly income from credit card interest and fees minus net charge-offs; (11)

time a continuous time counter.

Bank deposits were found to be a better size measure than assets. Besides the variables listed earlier, the

following enhancements to credit card plans were included in the regression: (12)

rebate rebates on purchases;

warrant extension of manufacturer's warranty;

protect purchase protection;

accid travel accident insurance;

tradisc travel related discounts;

auto automobile rental insurance buydisc purchase discounts (other than travel); regis credit card registration; other any other enhancements.

We found that the net revenues from credit cards were higher for banks that charged higher interest rates, minimum finance charges, and late fees (Table 7). Despite a higher probability of default, maintaining high interest rates may be profitable for banks. As banks raise their interest rates, some customers may switch to other credit card issuers. Because switching may be easier for cardholders in good standing, those who remain are more likely to be behind on their payments and may end up generating higher income from interest and fees. Raising the annual fee, however, was estimated to lower the issuer's net revenues. The annual fee is the only charge that must be paid by all three groups of cardholders, and even the borrowers who do not intend to carry balance on their cards (and therefore are not sensitive to interest rates or other fees when selecting a credit card plan) may be discouraged by high annual fees. It is not surprising, therefore, that the fee has been eliminated on many credit card plans.

The mean quarterly net revenues from credit card interest and fees for the sample were $14.78 million (in 1999 dollars). Evaluating at the mean, banks with an APR that was 1 point higher than the average (approximately one-half of a standard deviation) were estimated to have $4 million higher net revenues (one-tenth of a standard deviation). An increase in the late fee of one-half of a standard deviation would raise the net revenues by $3 million, and a similar increase in the minimum finance charge would raise the net revenues by over $8 million. Some enhancements were found to lower net revenues, but others increased them. The most profitable enhancement was found to be purchase protection.