3.1 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

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.

3.2 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.

3.3 Finally, this chapter briefly assesses the profitability of the credit card market in Australia.

3.4 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

2 These figures were set out in greater detail in chapter two.

22

3.5 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

3.6 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

card interest rates has grown, and consumers have been left paying higher rates of

interest overall.

3.7 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

Committee Hansard, 27 August 2015, p. 10.

4 Abbas Valadkhani, Sajid Anwar and Amir Arjomandi, 'Downward stickiness of interest rates in

53; Professor Abbas Valadkhani, Department of Accounting, Economics and Law, Swinburne

5 Professor Abbas Valadkhani, Department of Accounting, Economics and Law, Swinburne

23

3.8 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

3.9 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

3.10 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 nonperforming

loans and funding costs. Rather, the spread seems to incorporate

3.11 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

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

27 August 2015, p. 51.

p. 53.

8 Mr Michael Willcock, Acting Deputy Secretary, Markets Group, Department of the Treasury,

Proof Committee Hansard, 22 September 2015, p. 55.

3 September 2015, p. 20.

24

well. But the bottom line is that, clearly, the consumer is not acting to try

3.12 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

3.13 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

3.14 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

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

3.15 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

27 August 2015, p. 42.

12 Mr Stephen Henry Mickenbecker, Group Executive, Ratings and Financial Services,

Hansard, 22 September 2015, p. 35.

p. 54.

25

might generally expect that they will not be paying interest on credit card debt, in fact

3.16 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.

26

3.19 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.

3.20 Asked about the possibility of regulating prices in the credit card market, CHOICE sounded a note of caution:

3.21 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.

3.22 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

Committee Hansard, 27 August 2015, p. 32.

27 August 2015, p. 56.

22 The 11.6 per cent figure is from the March 2015 quarter. For more detail, see chapter two.

27

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

on capital (the primary measure of profitability) for its credit card portfolio had

3.23 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

3.24 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

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

3.25 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

23 Mr David Robert Lindberg, Chief Executive, Commercial and Business Bank, Westpac Group,

Proof Committee Hansard, 16 October 2015, p. 25. ANZ provided similar figures to the

Hansard, 16 October 2015, p. 60.

24 Mr David Robert Lindberg, Chief Executive, Commercial and Business Bank, Westpac Group,

Proof Committee Hansard, 16 October 2015, p. 15.

25 Mr David Robert Lindberg, Chief Executive, Commercial and Business Bank, Westpac Group,

Proof Committee Hansard, 16 October 2015, p. 15.

26 Mr Antony James Cahill, Group Executive, Product and Markets, National Australia Bank,

Proof Committee Hansard, 16 October 2015, p. 32.

28

by $8.6 billion, and 'the excess of repayments over transactions is now at a record high

3.26 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

3.27 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

3.28 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

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

28 Mr Anthony Pearson, Chief Economist and Executive Director, Industry Policy, Australian

29 Mr Anthony Pearson, Chief Economist and Executive Director, Industry Policy, Australian

Committee Hansard, 27 August 2015, p. 15.

27 August 2015, p. 37.

29

3.30 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

3.31 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

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:

33 Mr Matthew Comyn, Group Executive, Retail Banking Services, Commonwealth Bank of

Committee Hansard, 16 October 2015, p. 60.

34 Mr Anthony Pearson, Chief Economist and Executive Director, Industry Policy, Australian

16 October 2015, p. 60.

30

…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,

3.32 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

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

3.33 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

3.34 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

economic cycle was a 'much more significant contributor' to credit card pricing than

profitability needed to be considered over the entire economic cycle:

37 Mr Anthony Pearson, Chief Economist and Executive Director, Industry Policy, Australian

38 Mr Antony James Cahill, Group Executive, Product and Markets, National Australia Bank,

Proof Committee Hansard, 16 October 2015, p. 32.

Committee Hansard, 16 October 2015, p. 58.

42 Mr Matthew Comyn, Group Executive, Retail Banking Services, Commonwealth Bank of

31

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

3.35 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

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

3.36 Higher default risk on credit cards was also identified by some as a factor in

determining interest rate settings. For example, Bank Australia stated:

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

3.37 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 writtenoff

directly to an issuing institution's profit and loss account, without first

43 Mr Matthew Comyn, Group Executive, Retail Banking Services, Commonwealth Bank of

3 September 2015, p. 19.

32

3.38 The RBA advised that the current 'loss rate' on credit cards was about

annual level of credit losses for credit cards is around 2.52 per cent of outstanding

advised that proportional defaults and losses were significantly higher for credit card

3.39 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 ABA:

…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

3.40 ANZ presented the following breakdown of industry-wide credit card

operating costs, drawing on data provided by Argus Information and Advisory

Services:

RBA rates influence funding costs, funding must also take into account credit

risk, and liquidity characteristics of credit card financing.

costs include credit related losses, consumer protection and protection against

fraud.

administration, points reward, discounts and travel insurance.

infrastructure, processing, settlement, foreign exchange services and customer

3.41 ANZ commented that these operating costs do not include material additional

costs of providing credit card services, including: the capital investments associated

48 The RBA explained that the 'loss rate' was a more useful measure than the non-performing loan

rate, as non-performing loans can become performing again and even if a non-performing loan

is written off there may be some recovery. Dr Anthony Richards, Head, Payments Policy

50 For example, Mr Antony James Cahill, Group Executive, Product and Markets, National

33

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

3.42 In determining whether current interest rate settings on credit cards are

justifiable, the committee sought to ascertain the profitability of the credit card

market.

3.43 The RBA explained in its submission that credit card issuers earn revenue on

their credit card portfolios from three major sources:

2014, or $90 per account;

'companion' card transactions, which based on incomplete data the RBA

estimated at approximately $1.5 to $1.75 billion in 2014; and

3.44 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 profits.

3.45 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

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 profit

also:

…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

55 Mr Matthew Comyn, Group Executive, Retail Banking Services, Commonwealth Bank of

16 October 2015, pp. 19–20; Mr Antony James Cahill, Group Executive, Product and Markets,

34

adjust it according to the risk characteristics of the product. So you have to

card portfolio, advised the committee that its return on capital for its credit card

portfolio had remained stable over the past five years:

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

3.47 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.

3.48 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 the process.

16 October 2015, p. 60. ANZ explained that while it typically did not disclose unit profits, 'in a

sense it is not a material profit for the group', which is why they could disclose it without

having to do a market disclosure. Mr Graham Hodges, Deputy Chief Executive Officer, ANZ,

Proof Committee Hansard, 16 October 2015, p. 62.