Have bank capital rules made credit card borrowing more expensive?


Although defaults are low, rates for credit card backed banknotes are high

Since the 2008 financial crisis, when the Federal Reserve maintains interest rates, mortgages, auto loans, and student loans have all become cheaper.

But there is one notable exception: The typical interest rate charged on overdue credit card balances has increased. Before the crisis, the average interest rate hovered around 15%. Today it is closer to 16.5%. And Matthias Fleckenstein of the University of Delaware and Francis A. Longstaff of UCLA Anderson, drawing on data from prospectuses, say that, including fees charged to consumers, the rate is around 20%.

But it was not a systemic increase in losses for credit card issuers that triggered the rise in credit card rates after the crisis. Among the top 100 banks, the write-off rate for credit card loans has steadily declined since the height of the crisis. After peaking at over 10.5% in 2010, the imputation rate has been below 4% since mid-2012. (For the record: in the decade leading up to the financial crisis, the average write-off rate for major banks was typically over 4%.)

A working paper published by the National Bureau of Economic Research suggests that the stubbornly high level of credit card rates charged to consumers may be in part a function of a marked change in the pricing of securitized credit card loans since the crisis. financial. Washington’s post-crisis decision to curb risk-taking on Wall Street appears to have fueled this shift.

“Recent capital regulations may have added hundreds of basis points to the overall cost of obtaining unsecured consumer credit in the credit card market,” Fleckenstein and Longstaff write.

Like student loans, mortgages, and auto loans, credit card loans are just the beginning of Wall Street’s source of income. Packing loans (that’s what your unpaid credit card bill is, after all) into notes for institutional investors is also a profitable endgame. Credit card-backed securities totaled more than $ 83 billion at the end of the second quarter of 2020.

Credit card balances are single debt because the loans that back them are unsecured and can be discharged in bankruptcy. It is therefore not surprising that institutional investors expect a significant margin of safety. Fleckenstein and Longstaff reveal that this risk premium has widened considerably since 2010.

In an analysis of credit card ABS activity for the top 10 banks from 2000 to 2020, Fleckenstein and Longstaff quantify the risk premium based on their analysis of actual market prices for credit card ABS. (These 10 banks dominate the credit card market, holding about 80% of outstanding balances.)

The authors find that in the early 2000s, the average risk premium for credit card-linked ABS was typically around two to three percentage points. In 2020, it was almost 15 percentage points.

Recognizing that institutional investors have long viewed unsecured credit card debt as a close cousin of corporate bond risk, the authors examined whether the trajectory of the credit card risk premium was in line with the spread. the high yield bond market. As shown in the graph below, the rise in credit card ABS risk premium over the past decade does not appear to be linked to a general revaluation of the safety margin among the riskiest asset classes. .

In addition, they find that among the large card issuers, the charge-offs during the crisis did not result in net losses for their ABS investors. Fleckenstein and Longstaff calculate the “excess spread” for ABS securities, which measures what is left to the issuer after collecting payments from consumers and then making payments (and fees) to investors in ABS. As long as the excess spread remains above zero, the issuers are whole and the investors receive their interest (and possibly the repayment of the principal). As shown below, the excess spread did not reach zero during the financial crisis.

As to why it has since skyrocketed, a series of calculations lead the authors to rule out a few possibilities (e.g. charges are not at issue) and postulate that changes in federal regulation of banks (card issuers credit) which began in 2010 explain the sharp increase in the consumer credit risk premium.

A major change in federal accounting regulations required banks to shift their credit card receivables (fees that consumers have not yet paid) to their balance sheets. At the same time, capital requirements have been raised. And a key feature of the financial reforms of the Dodd-Frank Act required that issuers of securities maintain some “skin in the game” by owning at least 4-7% of each security they issued.

“We find that much of the increase in the consumer credit risk premium over the past decade may be due to the impact of capital regulations.”

Their research did not explicitly focus on whether the change in credit risk premium that they document is a full explanation for why the rates of consumers with paid credit card balances don’t. have not fallen after the crisis with other borrowing rates. But it does seem to indicate that in the process of controlling risk-taking on Wall Street, it is the consumer who foots the bill for increased operating costs.

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