Credit Card Banking

Drechsler, Itamar; Jung, Hyeyoon; Peng, Weiyu; Supera, Dominik; Zhou, Guanyu

doi:10.59576/sr.1143

Report

Credit Card Banking

Abstract: Credit card interest rates currently average 22 percent, an 18 percent spread over the short rate. This spread far exceeds that on any other loan or bond, yet nearly half of households are credit card borrowers. Why are credit card rates so high? To understand this, and the economics of credit card banking, we use regulatory account-level data to analyze the lifetime cash flows of 550 million monthly accounts, representing 90 percent of the U.S. credit card market. While charge-off rates are comparatively high, averaging around 6 percent, they explain only a fraction of cards’ spread. Reward payments and noninterest expenses are more than offset by interchange and non-interest income. Operating expenses, particularly marketing, are very large and are used to generate pricing power. Yet after deducting them, card lending still earns a 6.8 percent return on assets (ROA), more than four times the banking sector’s ROA. Using the cross section of accounts, we estimate that credit card rates price in a 4.3 percent default risk premium, similar to high-yield bonds. Accounting for this, card lending earns an alpha of around 1.5 percent relative to the aggregate bank sector.

JEL Classification: G12; G21; G51;

https://doi.org/10.59576/sr.1143