Developments in the pricing of credit card services

Federal Reserve Bulletin, Sept, 1992 by Glenn B. Canner, Charles A. Luckett, Wayne C. Cook, Mark A. Peirce

Although cash and checks continue to be the dominant means of completing transactions, credit cards are an important and growing alternative. In 1990, according to one private-sector source, credit cards were used by consumers to purchase some $445 billion worth of goods and services. In that year, credit card charges accounted for about 13 percent of all consumer expenditures, up from 10.8 percent in 1980.(9)

The growing share of consumer expenditures completed by credit card attests to the advantages of this means of conducting transactions, including convenience, safety, automatic recordkeeping, and, in most cases, an interest-free grace period for settling accounts. Although some card issuers charge consumers a fee for each purchase, most do not (fewer than 2 percent of the roughly 160 issuers covered by the March 1992 E.5 statistical release assessed a transaction fee on each purchase). On many plans, cardholders are assessed an annual fee to hold a card, but most annual fees are unrelated to the volume and frequency of purchases.

Consumers who use a credit card principally as a payment device most likely would, in selecting a card, focus on the level of any annual fee, the length of the grace period, the availability of desirable enhancements, and the level of authorized charges (the credit limit). The stated interest rate is unlikely to be of much importance to consumers who view their cards mainly as a transactions device.

Credit Cards as a Source of Credit

The interest rate charged may be more critical to consumers who view a credit card as a debt instrument and regularly roll over part of their balances to future billing periods, incurring interest charges to do so. Credit cards today account for a substantial and growing share of consumer installment debt (chart 2). Revolving credit (mainly outstanding balances on credit cards) stood at $60 billion at the end of 1980, representing 19 percent of all consumer installment debt. By the end of 1991, revolving credit had risen to more than $240 billion and accounted for roughly one-third of consumer installment debt outstanding. The portion of this amount that represents convenience use is unknown, as it is impossible to break down the aggregate statistics into balances owed by different types of users. No doubt a substantial portion of outstanding balances at any one time are accruing interest charges. However, even people who use credit cards as a means of borrowing may differ substantially in the specific ways they use their cards. As is discussed later, these differences can bear significantly on the interest rate sensitivity of consumers and the nature of competition in the credit card market.

COSTS OF CREDIT CARD OPERATIONS

Both the level of credit card interest rates and the changes in rates over time reflect the costs of providing credit card services. Therefore, an understanding of the behavior of credit card interest rates rests in part on an examination of costs. Two aspects of the cost issue warrant particular attention: comparative performance across product lines and comparative performance among different card issuers.