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Regulatory tricks, to their credit, in our interest - SMH, Clancy Yeates
Shopping sprees are a natural part of summer for many people, just like the roar
of cicadas or a sudden interest in yacht racing. But there's a big difference
between how consumers are spending today compared with how they did in previous
years: the shrinking role of credit card debt.
Latest figures show the average credit card balance fell by the largest proportion on record in the year to October, dropping 2.7 per cent.
That is a dramatic change from the 2000s, when credit card debt increased nearly fourfold in a decade.
So, why are so many Australians turning away from credit card debt?
The well-known reason is that we've become more conservative with our finances.
But I think this is only part of the story. After all, there hasn't been the same degree of change with other types of debt, such as home loans.
Most shoppers wouldn't realise it, but another drag on credit card use may also come from behavioural economics - which borrows from psychology.
As card balances continue to slide, there's early evidence to suggest that reforms based on behavioural economics have gently nudged Australians into using their credit cards more sparingly.
It's just one way in which this branch of economics can subtly encourage people to make smarter financial decisions.
With interest rates of up to 20 per cent, credit cards are a very expensive way of borrowing money.
Financial counsellors advise people to avoid paying credit card interest if they can manage it, by paying the entire bill each month.
Yet it remains a lucrative business. About $34 billion in credit card debt is racking up interest at often sky-high rates.
And some of this is being paid back very slowly, maximising the interest revenue for banks.
According to an ANZ survey quoted by the academics, 13 per cent of people pay only the minimum repayment - a recipe for years of indebtedness.
So, how do card issuers persuade us to take on debt at such high rates, which many of us pay back very slowly?
This is where economics comes in. Ali, McRae and Ramsay argue there are two types of credit card users.
Most are ''transactors'' - who generally pay off the full debt every month and avoid paying interest altogether. The other group is the ''revolvers'' - people who pay less than the full repayment each month, and account for most of the interest paid.
On top of this, the academics highlight two behavioural ''biases'' many of us have.
One is optimism, such as underestimating the chances we might lose our job, and the other is a tendency to overestimate our self-discipline.
The researchers argue that credit card issuers profit from these biases through complex pricing structures, whereby perks such as low fees or rewards schemes are offset by very high interest rates.
When all the costs are ''bundled'' together they can be hard for consumers to understand. ''Revolvers'' in particular are at risk of borrowing more than is sensible.
So, what has changed?
In an attempt to reduce hardship caused by credit card debt, recent policies were designed with these behavioural quirks in mind.
Previously, it was assumed people were rational and simply disclosing the complex information was enough. But these days policymakers are acknowledging we're not always so rational after all.
For one, the banks have been forced to ''unbundle'' complex information when communicating with customers.
Since mid 2012, every credit card statement has included a projection of how long it would take to repay the debt if you only made the minimum monthly payment, rather than assuming people can work this out for themselves. (For the average debt of $3164 at an interest rate of 15 per cent, it's 18 years.)
As well, lenders can now offer credit increases only to people who have said they want to receive them.
This is another psychological trick designed to deal with the ''optimism bias'' that causes people to take on more debt than they should.
Research shows we're less likely to do something if we have to go out our way - such as granting the bank prior permission to offer credit increases.
And guess what? After growing at double-digit rates five years ago, average credit card limits are at a virtual standstill. It's early days, but legislation designed to change consumer behaviour seems to be making a difference.
Credit card issuers are not sitting by while balances fall, of course. They are coming up with new tricks to get us borrowing.
For instance, the number of cards that offer a balance transfer at an interest rate of zero have more than doubled in the past year, Finder.com.au reports.
But while these sound attractive, the catch is that interest charged on new purchases is high, often about 15 per cent.
''Interest-free'' finance deals promoted by retailers are generally worse. The watchdog, the Australian Securities and Investments Commission, says these typically revert to an interest rate of 28 per cent.
There will always be money to be made by exploiting people's tendency to be optimistic or undisciplined with their finances. But the experience with credit cards suggests behavioural economics can prevent us falling into some of these traps.