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Why the banks sting you on credit card rates -
If the banks aren't competing on their rates, how do they compete, then? Photo: Jessica Hromas
There is a paradox in the $50 billion credit card market that has left some of our brightest economists scratching their heads.
Interest rates for just about every other type of debt have plunged in the past few years, but average credit card rates have edged up, to a whopping 19.75 per cent.
At first glance, it's not what you'd expect from a competitive market, raising the question of whether consumers are being ripped off.
The top brass of Treasury and the Reserve Bank were asked about the record gap between credit card rates and the RBA cash rate by Labor senator Sam Dastyari last month. They conceded it was a "good question" and they'd take a closer look.
Now, with a Senate committee also investigating the issue, Treasury this month published an earlier "deep dive" into what's behind our sky-high credit card interest rates.
Yet Treasury has essentially advised Joe Hockey there's no systemic problem in this part of the banking market.
Its brief to Hockey, prepared in March and released under freedom of information laws this earlier month, confirms Dastyari's suspicion that credit card interest rates have been "unresponsive" to changes in funding costs.
Indeed, it estimates the gap between banks' funding costs and rates paid by borrowers has widened since the global financial crisis, from about 6.7 per cent to 8.7 per cent.
However, Treasury doesn't think this proves a lack of competition. Far from it. Instead, it reckons there is "heightened competition" between banks to win each other's customers (deploying 'Smoke & Mirrors' with deceit over Transfer Balance, Loyalty Points etc - not competing on interest rates). Even though the big four banks control about 80 per cent of this market, it says this is no different to home loans, where competition has forced down interest rates.
What is more, it says consumers seem willing enough to change credit card providers – in contrast to other parts of banking where switching is a hassle, like transaction accounts.
So, what is going on? If this market really is competitive, as Treasury says, why have rates stayed so stubbornly high?
Before looking at this anomaly, it's helpful to look at how banks make most of their interest income from credit cards.
There is about $50 billion in credit card debt outstanding, of which about $33 billion is racking up interest, but this burden is not shared equally among customers.
Most of the banks' interest return comes from one-third of their customers, who pay less than the full repayment each month and therefore keeping a revolving balance, known as "revolvers".
Another one-third or so of customers pay interest occasionally, while the rest are the disciplined types who pay off their balance in full every month.
The thing is, most customers don't intend on becoming "revolvers" when they sign up for a credit card.
Most of us assume we probably won't be paying interest at all, even if psychological research has found many of us have a natural tendency to overestimate our self-discipline with spending, while underestimating how hard it might be to repay these debts. Click on: Regulatory tricks, to their credit, in our interest
Since we assume we won't be paying credit card interest, we take little notice of what the rate is when we sign up for a card. A 2013 Choice survey cited by Treasury found almost half of customers don't know what their interest rate is.
That's very different to the approach people take when shopping for a home loan, where there is a whole industry of brokers advising people on which rates are lowest. And banks are happy to exploit this situation.
"High and inflexible interest rates could be seen as financial institutions taking advantage of the this user inattention to credit card interest rates," Treasury says.
"Card providers may also be reluctant to compete on their relative interest rate offerings since this would draw attention to the fact that their interest rates are high in an absolute sense."
But if the banks aren't competing on their rates, how do they compete, then?
In the main, they do it by trying to convince customers to shift their balances to a rival card with a low rate for a limited time. Almost three quarters of the cards monitored by the RBA are offering discounted balance transfer offers – what the Treasury calls "heightened" competition.
The challenge for the banks, however, is that the credit card business model is not as profitable as it once was, because consumers have become better at managing this very expensive form of debt.
Fees are also rising much more slowly, increasing by 1.4 per cent a year since 2009, after a three-fold surge in fees between 2000 and 2008.
Credit cards are still lucrative for banks – Treasury estimates return on equity of 40 per cent, slightly less than a home loan for the big four.
But the boom days of surging balances are in the past, and that has left the banks trying to make up the revenue shortfall through in other ways.
You can probably guess how they are doing that: by keeping rates high, thereby stinging their interest-paying customers.