Explaining the 'stickiness' of credit card interest rates
As explained in the previous chapter, different measures of credit card
interest rates offer different insights into whether those rates are fair and
appropriate, or whether, as Mr David Koch put it, average Australians are
getting 'fleeced at every step on the credit card journey'.
During the inquiry, critics of card providers pointed to the 'stickiness' of
headline (advertised) interest rates, arguing that for revolvers, this was the
most meaningful measure of interest costs. Card providers, however, pointed to
declines in the aggregate interest paid on their entire credit card portfolios
(the 'effective' interest rate). This chapter outlines and assesses the
relative merits of these different perspectives.
To the extent that credit card rates have not declined in line with the
RBA cash rate—and this has certainly been the case with regard to headline
interest rates, and to a lesser extent the average rate paid by credit card
'revolvers'—this chapter explores the reasons for this 'stickiness'. Again, the
committee received conflicting explanations for this phenomenon. Card providers
argued that funding was only part of the cost base of credit cards, and
referred to a range of other significant costs influencing credit card pricing.
Others, however, argued that the growing gap between the cash rate and credit
card interest rates could only be explained by the fact providers were taking
advantage of consumer inattention to credit card interest rates. This chapter
outlines and assesses these arguments, and considers the need for reforms
designed to better focus consumer attention on credit card interest rates.
Finally, this chapter briefly assesses the profitability of the credit
card market in Australia.
'Up like a rocket, down like a feather': Credit cards and the RBA cash rate
Two related measures of credit card interest rates (that often attract
the most public scrutiny), are headline rates and the gap between average headline
rates and the RBA cash rate. As noted in chapter two, headline interest rates
on standard cards currently bunch around 20 per cent, while low-rate cards
tend to be set at 13 per cent or thereabouts. The average headline
rate—the effective rate for cardholders who are paying interest on their
balances—is around 17 per cent. There is therefore a 15 per cent
gap between the average headline rate on credit cards and the current RBA cash
rate of 2 per cent. In 2007, the same gap was around
8 per cent.
A number of witnesses during the inquiry questioned whether current
headline rates and the gap between headline rates and the RBA cash rate (or,
alternatively, between headline rates and the costs of funds) could be
adequately explained simply as a function of the costs of providing the
facility. Dr Edey from the RBA, for instance, suggested that while there
was a great deal of variation in interest rates across the credit card market,
rates at the higher end of the spectrum could not be easily explained:
Interest rates in the order of 20 per cent on credit cards
are not uncommon. The average rate for borrowers who incur interest on credit
cards is currently about 17 per cent. Once you deduct from that banks' cost of
funds and the cost of credit losses, that would equate to an interest margin of
more than 10 percentage points.
Professor Valadkhani provided the committee with research he had
undertaken indicating that credit card providers appear to behave
asymmetrically in response to changes in the RBA cash rate. According to
Professor Valadkhani, between 1990 and 2012 the banks had immediately
passed on 112 per cent of RBA cash rate increases (the full value of
increases, plus 12 per cent), but only 53.7 per cent of
rate cuts: but cuts were delayed by an average of two-and-a-half months.
Professor Valadkhani has suggested this asymmetry is an example of the
'rockets-and-feathers' effect: credit card interest rates 'shoot up like a
rocket' in response to RBA cash rate increases, but 'float down like feather'
when the cash rate is decreased.
This means that over time the gap between the RBA cash rate and credit card
interest rates has grown, and consumers have been left paying higher rates of
Professor Valadkhani took issue with the banks tendency to downplay
the relevance of the cash rate to credit card interest rates:
We do not have enough information about what their funding
sources are. The argument they always make is: 'We cannot pass rate cuts on
because our sources of funding are different—it is not just the cash rate; it
is our external sources.' My argument to banks is: if that is the case, how
come, when the cash rate goes up, you immediately lift your rates? You may have
other external sources that are not related to the cash rate, but you increase
your rates anyway. When the cash rate goes down, though, you resort to the
argument of external sources.
CHOICE noted that despite a falling cash rate, average credit card
interest rates had gone up for both standard-rate and low-rate cards in recent
years. This was of particular concern to CHOICE, because:
...if you must have a credit card and you are on a low income
that means you cannot pay off your balance every month, a low-rate card is the
best option. So to see banks taking advantage of drops in interest rates to dip
their hands deeper into the pockets of low-income consumers is of deep concern.
The role of behavioural biases in informing credit card interest rates
An important finding of this inquiry is that consumers do not appear as
focused on the interest rates on credit cards as they are for other lending
products (such as personal or home loans). In fact, CHOICE told the committee
that its consumer survey suggested that 64 per cent of people do not even
know their credit card interest rate, up from 48 per cent in 2013,
suggesting a 'growing problem'.
The committee received evidence suggesting consumers' apparent
inattention to credit card interest rates was likely a factor in the prevalence
of high-interest credit cards, reducing pressure on card providers to compete
on interest rates. Treasury suggested that the 'large and widening spread
between funding costs and headline credit card interest rates' could be
explained in part by consumer inattention:
The spread appears not to just reflect pricing of credit risk
or non-performing loans and funding costs. Rather, the spread seems to
incorporate as well a premium reflecting consumer inattention to headline
Bank Australia made a similar point, telling the committee that the
spread likely reflected the fact that people are 'not terribly rate sensitive'
when they choose a card, because they expect to pay off the card balance in
full each month. In this sense, the spread was as large as it could be without
affecting the market's ability to sell credit card products.
Likewise, Mr Greenwood remarked that consumer inertia reduced the need for card
providers to lower their average rates:
There is clearly room for the banks to move these credit card
interest rates down. They have chosen not to do so and they have justified it
in all sorts of ways—in terms of the services they provide and the rewards they
provide. And they will give you an idea of the bad debts that are there as
well. But the bottom line is that, clearly, the consumer is not acting to try
and find a better deal.
Drawing on insights provided by behavioural economics, ASIC suggested
that people may give insufficient attention to a card's interest rate at the
point of application because they are naively optimistic about their ability to
pay their balance off in full each month.
Credit cards are multifaceted products, with features that have a
significant bearing, real or perceived, on the value proposition for a
particular consumer. For some consumers, the tendency to prioritise card
features such as rewards points may be entirely rational. As CANSTAR explained,
for big spenders who consistently pay off their full credit card balance each
month, the interest rate is irrelevant. For these customers, features such as rewards
programs are likely to be given a higher priority than interest rates. However,
CANSTAR emphasised that customers who do not consistently pay off the entire
card balance each month 'should not even consider rewards. The interest rate
will blow the rewards away'.
Despite evidence that interest rates are often the most salient feature
of a credit card, Treasury stated that competition is generally more intense on
other aspects of the value proposition, including balance transfer offers,
interest-free periods on purchases, rewards programs, and other benefits such
as insurance and concierge services.
CHOICE made a similar point, telling the committee that the banks were not
competing on interest rates, but instead on other generally less important card
features such as rewards points and balance transfers. To focus more
competition on interest rates, and thereby put downward pressure on them,
CHOICE suggested it was necessary 'to force the banks to give people the
information they need when they need it'.
The Customer Owned Banking Association (COBA) also argued that consumers
were more focused on credit card 'bells and whistles', and 'are not looking at
that interest rate as a key factor in deciding what product to take up'. This
also meant that card providers 'are not really competing on price in that
space'. The problem with this situation, COBA told the committee, was that
while consumers might generally expect that they will not be paying interest on
credit card debt, in fact a relatively high percentage of people (about
30 per cent) end up paying interest.
The committee believes there is strong and compelling evidence to
suggest that part of the reason credit card interest rates are so high is that
card providers know consumers often pay little attention to their significance.
Disclosure requirements in credit card advertising and other marketing could be
enhanced, and the committee considers that card providers should be required to
disclose the ongoing headline interest rate on a credit card in any advertising
or marketing material clearly and prominently. This requirement would be
established as part of additional disclosure requirements set out in
recommendation 1 in chapter four. These additional disclosure requirements are
intended to focus consumer attention on headline interest rates, and more
broadly enhance the ability of consumers to value and compare credit card
products in what is a very complex market.
Should credit card interest rates be regulated?
A number of submissions argued for limiting or otherwise regulating
credit card interest rates. The WA Consumer Credit Legal Service (CCLSWA),
argued that in order to protect low income, vulnerable, and disadvantaged
consumers, legal reform was required to 'limit the gap between cash rates and
credit cards rates'.
It argued that absent such action:
...it is likely that when cash rates rise, credit card interest
rates will rise considerably also. This will increase the already unfair and
disproportionate costs placed on low income, disadvantaged and vulnerable
consumers and will ultimately result in further long-term and severe damage to
these consumers' financial and emotional well-being. Further, with more
consumers experiencing serious financial hardship, there would be an increase
in demand on government and community services.
Similarly, the St Vincent de Paul Society recommended a legislative
requirement that 'credit card interest rates align with changes in RBA cash
Good Shepard Australia New Zealand argued that a failure to pass on the full
benefit of RBA cash rate cuts to credit card customers 'should be seen as an
exception, with credit providers being made accountable to the regulator and
consumers to apply for an exception to this rule'.
While Australia does not regulate interest rates, ASIC explained that
the United States had adopted an approach characterised by 'a strong commitment
to the direct regulation of fees and interest rates'. For example, increases on
interest rates, fees and other charges are banned in the first year of an
account being opened. Moreover, the United States has banned 'interest rate
increases on outstanding amounts except at the end of an introductory rate
period, if the rate is pegged to another rate that is not controlled by the
provider or if the borrower is more than 60 days delinquent'.
Asked about the possibility of regulating prices in the credit card
market, CHOICE sounded a note of caution:
As an organisation we are inherently cautious about anything
that involves price controls or price-fixing. Ideally, the best way to protect
consumers is to have effective markets that are supported by effective
competition. We would much rather think about how you protect consumers from
the negative effects of a market that is not working properly than price
interventions, because they tend to ultimately produce other distortions in the
system that have unintended consequences.
The committee acknowledges and shares the legitimate concerns raised by
some witnesses regarding the apparent unresponsiveness of credit card interest
rates to declines in the RBA cash rate. However, the committee does not agree
that credit card interest rates should be regulated. Rather, the committee considers
that the best way to put downward pressure on credit card interest rates is
through regulatory and policy interventions designed to improve the competitive
dynamics of the market and enhance the ability of consumers to measure and
compare the value of products within that market accurately and easily.
Card providers: headline rates are steady, but effective rates have fallen
While much of the evidence received by the committee focused on headline
interest rates, credit card providers argued that the average effective rate is
a better measure of credit card interest rates. As explained in the previous
chapter, this is calculated as the percentage of gross interest paid on
balances outstanding. According to the RBA, this figure currently stands at
11.6 per cent, which is not only significantly lower than the average
headline rate of about 17 per cent, but also 2 per cent
lower than the average effective rate in 2011 when the current easing cycle for
the RBA cash rate began.
These figures were supported during the inquiry by evidence provided by the
banks. For example, Westpac told the committee that the current effective
interest rate for its entire card portfolio was 11.27 per cent, which
was down from over 13 per cent in 2010.
Westpac also advised that its current return on capital (the primary measure of
profitability) for its credit card portfolio had remained flat over the past
five years, despite the declining cost of funds.
In large part, the difference between headline rates and effective
interest rates was influenced by three industry-wide factors which had offset
the benefit of a reduction in the cash rate. As Westpac explained:
First, more customers are spending more and paying off their
cards in full [each] month. This means that banks are funding higher balances
that are in the interest-free period. In the last three years, interest-free
balances have grown by around 45 per cent. In industry speak, the revolve rate
has declined. Second, a higher percentage of balances are being held in lower
rate cards. This means that the effective average interest rate has declined
relative to the headline rate on these products. Finally, low or zero rate
balance transfers are becoming a much larger component of the market, with zero
for 18 months becoming the industry standard. Balances in this category earning
no interest have grown considerably.
Similarly, NAB explained that the effective interest rate on its credit
card portfolio had been falling, in part due to the increasing numbers of
cardholders moving to low-rate cards and taking advantage of
zero per cent balance transfer offers (which are discussed further in
ANZ also noted that trends in consumer behaviour in recent years have had 'the
combined effect of reducing the total amount of interest bearing debt in the
Australian credit card market and lowering the net effective interest rate that
credit card providers receive on the lending they provide'.
The ABA referred to data from July 2015 showing that while the number of
cards and value of transactions had continued to grow in recent years, the
gross amount of outstanding credit card balances accruing interest was actually
at the lowest level in six years. Repayments over the year to July 2015 had
exceeded transactions by $8.6 billion, and 'the excess of repayments over
transactions is now at a record high level and continues 10 years of
strong repayment activity'.
While effective credit card interest rates have fallen in absolute terms
in recent years, the spread between credit card effective interest rates and
bank funding costs has increased from a relatively stable average of
6.7 per cent in the years prior to the GFC to an also stable average
of 8.7 per cent in the years since (see Figure 5 in chapter two).
Several witnesses said that this shift could be explained by the global
repricing of risk following the GFC. This repricing, the ABA remarked, was by
no means unique to the credit card market, but was in fact reflected in a
widening in the spread between cash rates and a range of lending and deposit
products, both in Australia and internationally.
Treasury indicated that the general repricing of credit across advanced
economies in the aftermath of the GFC:
...may be attributable to a general under-appreciation of
credit risk prior to the crisis, particularly on unsecured lending, but may
also reflect a failure to properly price default correlations across asset
classes and their propensity to increase following a shock to the financial
While measuring credit card interest rates using the effective interest
rate might appear a logical approach, it must be emphasised that this measure
is of little relevance to cardholders who are actually paying interest on their
balances. The average rate paid by revolvers (17 per cent) has only
fallen about 1 per cent since 2011, against declines in the average
effective rate of 2 per cent and in the cash rate of
2.75 per cent, which would suggest an increase in the extent to which
'revolvers' are subsidising 'transactors'. This cross-subsidisation in the
credit card market was raised by Dr Edey from the RBA, who noted that 'different
kinds of customers incur different fees and different levels of interest
Mr Greenwood was more direct in his criticism of this cross-subsidisation,
declaring that 'we have a system where some of the poorest and most vulnerable
in our community subsidise the wealthiest in our community'. 
Card providers: funding costs only one component of credit card costs
Beyond emphasising the importance of focusing on effective interest
rates instead of headline rates, card providers asserted that the RBA cash rate
was one of many components of the cost base of credit cards. CBA and NAB
advised the committee that the cost of funds only accounted for approximately
22 per cent of the costs of providing a credit card; similarly, ANZ
reported that it was less than 25 per cent.
The industry average of the costs of fund as a proportion of the overall cost
base, as reported by the ABA, was slightly higher, at about one third. As a
relative proportion of the cost base of providing credit cards, the ABA added, this
figure had 'fallen substantially over the past six years'.
Westpac also maintained that the 'link between Credit Card headline
(advertised) rates and the official cash rate is low'. Westpac added:
The RBA's discussion paper, 'The Evolution of Payment Costs
in Australia', confirms that funding costs are a low component of overall
Credit Card issuing costs and consequently the official cash rate has a
negligible impact on card economics. Rather, the highest Credit Card costs are
associated with high operation costs, payments functionality (such as real-time
systems) and the rich bundle of benefits associated with Credit Card products.
While public commentary often focuses on the low correlation between the
cash rate and credit card interest rates relative to the correlation between
the cash rate and mortgage lending rates, the banks asserted that the
comparison was misleading. ANZ stated that whereas funding costs only accounted
for less than 25 per cent of credit card costs, they made up about
85 per cent of the cost base for mortgages. Given this difference,
ANZ continued, it was not surprising that the relationship between product
interest rates and the cash rate is less direct for credit cards.
The ABA made a similar point, aruging it was misleading to compare credit card
pricing with interest on straight loan products. Credit cards, the ABA
submitted, are a more complex product that other loan products:
...because of their payment convenience, the fact that they
have 24/7 access to what is a rolling credit facility and the fact that they
involve third parties, such as the providers of the credit card infrastructure.
NAB advised that banks have had to 'change their funding mix over time
and move to more stable funding mixes', observing that deposit rates have
increased in relation to spreads and wholesale funding costs have also
For non-bank card providers, the correlation between the RBA cash rate and
credit card interest rates is weaker still. For example, GE Capital explained
that its interest rates are not directly influenced by the RBA cash rate, and
depended on the state of wholesale funding markets, rather than the deposit
funded market. 
Credit risk and loss rates
Card providers also emphasised that because credit card lending is unsecured,
it is subject to higher risk profiles than many other forms of lending, arguing
that the pricing of credit cards (including interest rates) is in part a
reflection of this higher risk, and the fact that credit card lending attracts
higher risk weights than secured forms of lending. As ANZ advised:
This risk dynamic is well recognised by both the banks and
regulators as evidence by the risk weights applied to credit card limits (APRA
defined). While recent increases in mortgage lending requirements increased
risk weights to 25 per cent to account for the potential risk borne
by banks, the risk weights applied to credit card balances is significantly
higher at 40 per cent.
CBA explained that this higher risk, and the fact that credit is
available on an ongoing basis rather than for a fixed period, meant that the
pricing of credit cards was 'sensitive to market pressures and the economic
environment, particularly the unemployment rate'.
According to CBA, this need to price risk through the economic cycle was a
'much more significant contributor' to credit card pricing than funding costs,
and while credit card portfolios might look profitable over the short-term,
profitability needed to be considered over the entire economic cycle:
Whilst we have been fortunate to have periods of economic
growth in Australia, many markets have demonstrated that losses increase quite
dramatically in times of stress. So our default rates, for example, tend to be
in the range of two to three per cent; if you look at the US experience over
the last five years, they peaked at more than 10 per cent. So in any given year
the credit card business can look very profitable. Over the long term, there is
likely to be a year where it is distinctly less profitable—possibly unprofitable—and
our role of running a credit card business is trying to ensure that we run it
profitably over the long term.
Westpac made a similar point, submitting that credit card pricing
adjustments 'reflect broad changes over the economic cycle rather than as a
frequent, point-in-time response to individual movements such as changes in the
official cash rate'.
ANZ also noted that interest rate movements on unsecured credit products like
credit cards 'must take account of through-the-cycle loss rates and the
underlying economic factors driving reductions in cash rates (e.g.
Higher default risk on credit cards was also identified by some as a
factor in determining interest rate settings. For example, Bank Australia
Pricing still has to take into consideration that credit card
default risk and fraud risk is higher than with secured debt. Unsecured debt
forms the bulk of the bank's write-offs.
As the RBA outlined in its submission, the Australian Prudential
Regulation Authority's (APRA) non-performing loan (NPL) rate on banks' credit
card debt (that is, where repayment is more than 90 days past due or otherwise
doubtful) was 1.5 per cent in early 2015:
However, the overall loss rate for credit card issuers is
probably higher than suggested by the NPL rate. Unlike some other types of
household loans such as residential mortgages, credit card loans are unsecured,
with little prospect, in some cases, of recovering a significant portion of the
debt if the borrower defaults. As a consequence, some credit card debt may be
written-off directly to an issuing institution's profit and loss account,
without first being recorded as a non-performing loan.
The RBA advised that the current 'loss rate' on credit cards was about
2.5 per cent.
This corresponds with Westpac's advice to the committee that the annual level
of credit losses for credit cards is around 2.52 per cent of
outstanding balances, compared to around 0.02 per cent for secured
Other banks also advised that proportional defaults and losses were
significantly higher for credit card lending than for secured forms of lending.
Additional cost drivers
Card providers and the ABA referred to a range of factors contributing
to credit card costs that were unrelated to funding costs. According to the
...the cost of funds has become less important as a component
of overall expenses for credit cards. Scheme fees, value-added services and
rewards programs, and security and fraud management now comprise a greater
proportion of credit card product costs. There have also been additional costs
associated with improved technology such as contactless technology and
ANZ presented the following breakdown of industry-wide credit card
operating costs, drawing on data provided by Argus Information and Advisory
Funding costs are about 35 per
cent of total credit card operating costs. While RBA rates influence funding
costs, funding must also take into account credit risk, and liquidity
characteristics of credit card financing.
Credit management and fraud
comprise around 30 per cent of costs. These costs include credit related
losses, consumer protection and protection against fraud.
Rewards and product benefits are
around 27 per cent. These include scheme administration, points reward,
discounts and travel insurance.
Scheme fees are around nine per
cent. Banks pay for services such as infrastructure, processing, settlement,
foreign exchange services and customer service and support.
ANZ commented that these operating costs do not include material
additional costs of providing credit card services, including: the capital
investments associated with technology and regulatory requirements; contact
services for customers; research and intellectual property costs; marketing
costs; innovation and product development costs, and so on. Once these other
costs were taken into account, ANZ wrote, funding costs fell to 'well below
25 per cent of total costs'.
Profitability of credit card portfolios
In determining whether current interest rate settings on credit cards
are justifiable, the committee sought to ascertain the profitability of the
credit card market.
The RBA explained in its submission that credit card issuers earn
revenue on their credit card portfolios from three major sources:
Fees: which the RBA estimated accounted for about
$1.4 billion in revenue in 2014, or $90 per account;
Interchange revenues: or issuer fees, in the case of American
Express 'companion' card transactions, which based on incomplete data the RBA
estimated at approximately $1.5 to $1.75 billion in 2014; and
Interest payments: which APRA reported were around
$5.4 billion in 2014.
Beyond the fact that this data is imperfect, revenues are of course
distinct from profits but it is apparent that interest payments, as the largest
source of revenue for card providers, are a major driver of credit card
Three of the four major banks advised the committee that they were
unable to publicly disclose the profits earned on their credit card portfolios,
as they roll credit card outcomes into broader divisional outcomes before those
divisional outcomes are disclosed to the market.
In contrast, ANZ was willing to share its net profit after tax on its credit
card portfolio. ANZ Deputy Chief Executive Officer, Mr Graham Hodges,
told the committee the bank's credit card business accounted for approximately
$400 million, or 5 per cent, of group profit. He added that this
...accounts for five per cent of risk weighted assets, which is
the balance sheet adjusting for the risk profile. So the consistency there is
good. A credit risk weighted asset is that you get your product and then you
risk adjust it according to the risk characteristics of the product. So you
have to look at it in risk adjusted terms.
As noted earlier, Westpac, while not disclosing its actual
profits on its credit card portfolio, advised the committee that its return on
capital for its credit card portfolio had remained stable over the past five
The Westpac Group's current net margin for Credit Cards is in
line with 2010, with small movements up and down over the period. Therefore,
while funding costs have declined the overall profitability of the product has
not improved as funding cost reductions have been offset by declining revolve
rates, higher promotional rates and changes in product mix.
The committee does not dispute the banks' contention that the effective
interest rate on the total sum of outstanding credit card debt has fallen
slightly since 2011. However, the committee also suggests that the
effective rate provides little insight into how credit card 'revolvers' are
affected by credit card interest rates. Ultimately, the committee is less
concerned with the aggregate interest being paid by Australians on their credit
cards, than the fact that many Australians appear to be paying interest that is
well above what might be expected in a properly competitive market. This is
particularly concerning as it appears those cardholders paying interest are
often those who can least afford it.
The committee accepts that funding costs are only one component of the
cost base of credit cards, and acknowledges that it is neither realistic nor
reasonable to expect a direct correlation between the RBA cash rate and credit
card interest rates (however those rates might be measured). The committee does
not accept that high interest rates can be explained by cost alone. Rather, it
appears credit card providers are taking advantage of the relative inattention
of consumers to credit card interest rates, and earning significant profits in
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