The gap between what banks are being charged to borrow money, and what their charging consumers, is widening once again. According to the FT, US consumers are paying higher interest rates on credit-card balances than they have in 25 years.
The average rate on interest-bearing card accounts topped 17 per cent in May, according to Fed data, the highest in the 25 years that the central bank has been making the calculation. Weekly data based on a Creditcards.com survey of 100 national card issuers found an average rate of 17.8 per cent at the end of July, another multi-decade high.
Credit card rates started rising off their long-term lows as the Fed started raising the benchmark interest rate between late 2015 and the end of last year. But issuers soon outpaced the Fed, and rates continued to rise as the Fed embarked on its July rate cut. Now, the spread between the Fed funds rate and the rate that card issuers pay to hold deposits is, at just under 15%, the widest in recent memory. The spread has only been wider once: In the third quarter of 2009.
Analysts blamed a couple of factors for the aggressive rise in credit-card rates: The first, is the CARD Act of 2009, a US law designed to protect consumers from being exploited by credit-card companies. The law limits a banks’ ability to raise interest rates on existing balances. So, since card issuers "can't reprice you once they sell you a card - so they have to price [more risks] in," according to John Hecht of Jeffries, a broker.
Another factor? The perks. Card issuers need to bring in more capital to offset the generous perks that they've been awarding to loyal customers. (WSJ has chronicled the headaches that JPM has endured thanks to its extremely popular Sapphire Rewards Card).
Still, there's reason for card holders to be optimistic. Two of the biggest credit-card lenders cut rates after the July rate cut.
Since the crisis, card rates are often set by adding a premium to a fluctuating index - most often the prime rate, the lowest rate banks make available to non-bank customers. The prime rate in turn is directly related to the fed funds rate that is set by the Federal Reserve.
After the central bank’s decision to cut its benchmark last week, both JPMorgan and Citigroup, respectively the number one and two US card banks by loan volume, dropped their prime rates by a quarter of 1 per cent. This will flow through to the rates paid by many cardholders, at least initially. But card rates and prime rates do not move in tandem.
Credit card companies have found other tools to bring in cash, like charging annual fees.
Card companies have also found other ways to increase what card customers pay, for example by using annual fees, foreign transaction fees, and fees on balance transfers, according to Ted Rossman of Creditcards.com.
"I don’t think this [Fed] rate cut is a big gain to consumers with credit card debt - [their] rate is already high and even if it goes down slightly...[they] very well might end up paying higher fees in other areas," said Mr Rossman.
There is a record $850 billion in US credit card debt outstanding, according to the Fed. That's a record amount in dollar terms, though it has declined slightly as a percentage of GDP. With economic growth starting to slow, and wages still largely stagnant, banks are debating whether now is the time to push for more growth in their profitable credit card business (and create more balances that can be bundled into securities and sold off of the bank's balance sheet). Hopefully, those that opt for more high-interest rate loans at least understand the risks.