Bank credit cards, the lending and transacting products offered by domestic financial institutions, are risk-based products that permit a cardholder to transact on the card payments network. Credit cards differ from debit and prepaid products because they require the issuing bank to extend credit to the customer. Since credit products generate fees, interest, and interchange income, they are more profitable than debit cards or prepaid cards, which are pay-as-you-go.
As we have stressed in the past, although credit cards as a product type have greater revenue potential than debit or prepaid cards, credit risk carries a potential downside. Beyond the credit debt carried from month to month by households are the aggregate credit lines that facilitate cardholder accounts. Total unused open credit lines in 2018 reached $3.7 trillion, a major source of risk should a declining economy drive cardholders to tap into this available credit. Both revolving debt and the contingent liability of open credit lines require issuing banks to maintain performance standards that ensure the account remains current. Nonpayment will result in credit losses that directly affect an issuing bank’s profitability. Ideally, banks lose no more than 4% of their receivables to bad debt annually, but changes in household budgets and external economic factors can increase the loss rate and diminish credit card profitability. As the industry saw during the last recession, if the loss rate increases, credit card losses can be worth billions of dollars to large financial institutions. When other metrics start to turn negative, as when unemployment rises, household debt load increases, or lending is tighter, the 4% charge-off range can rise quickly.
The research report, Mercator Advisory Group’s 2020 Credit Card Data Book, reviews the performance of the general purpose bankcard industry in the United States.