The end of an era?
Requiem for the credit card?

The continuous growth of credit card spending has come to an end. Will Cain asks if this is a crisis or does it herald a more balanced future for one of banking’s most successful products?

After they were first launched in the UK by Barclaycard in 1966, credit cards became established as one of the most successful and profitable parts of the product mix in consumer banking.

After 40 years of almost continuous growth, the industry’s ability to generate income from the products is now being called into question. Since 2005, key credit card metrics, including outstanding credit balances, credit card transaction volumes and values, cash advances and balance transfers, all appear to have stalled.

In a more aggressive regulatory environment and economic conditions which require households to reduce debts, has the golden era of credit cards come to an end?

At the start of 2006, outstanding loan balances on credit cards were valued at £58.2 billion compared with the most recent figures for April 2011 of £57.8 billion, according to Bank of England figures. The number of credit card transactions grew at an annualised rate of just 0.2 per cent in the final quarter of 2010, according to figures from the UK Cards Association, while card spending rose 2.2 per cent.

Paul Rodford, head of card payments at the UK CardsAssociation, says that from a “very high growth trajectory” going in 2005, credit card volumes and values have stalled.

“The amount of credit stalled in 2005, the amount of cash advances that were taken on credit cards peaked in 2005 and are now back down to levels seen in the late 90s,” he says.

“Similarly, balance transfers are down to levels last seen in the late 1990s. The interesting thing is that all this happened in 2005 ahead of the credit crunch. Nothing happened in the 2007-2009 period that appeared in any way a reaction to the actual credit crunch.”

Regulatory pressure, even before the financial crisis, has been one of the biggest headwinds facing the industry. In 2006, the Office of Fair Trading ruled that default fees, the fees charged when a minimum monthly payment is not met, should not be more than £12, halving the fees charged by some issuers. More recently, the Cards Association has been working with the government to implement changes to the way issuers charge fees and provide information to their customers.

The six key changes, which were introduced in January this year, were communicated to consumers via a leaflet produced by the Cards Association and the Citizens Advice Bureau. They were:

1. The most expensive debit on credit cards will always be paid off first.

2. The minimum payment on credit cards will reducethe total outstanding balance, when previously they would only cover fees and interest charges.

3. Credit card companies will no longer be able to provide customers with credit card cheques unless they specifically request them.

4. Credit card companies have to contact customers separately from their monthly statement to increase credit limits, and customers are able to opt out if they say so within 30 days.

5. Changes to interest rates charged on the card, also known as re-pricing, will be subject to clearer communication and customers will be given 60 days to decide whether to accept or reject the new rate. If they decide to reject the new rate their accounts will still be closed.

6. More flexibility to choose the amount paid towards credit cards bills. Customers paying with automated instructions previously only had the option of paying either the minimum payment or the entire outstanding balance.

Rodford says the most important of these items was the payment of higher interest-bearing debt first, changes which are more far-reaching than similar regulation in the US, through the US Card Act.

“It creates winners and losers,” he says. “Those people habitually transferring between zero per cent offers would have lost out. Those who were caught out and didn’t realise they were paying off the lower interest debt first will benefit.”

The Cards Association modelled the financial impact of these changes as part of their consultation with the government on the changes. It estimates the total cost to the industry of the regulations introduced this year will be £300 million. Some of these costs will be absorbed by the industry, Rodford says, the rest will be absorbed by consumers.

Later this year, more changes are expected in the form of annual statements for credit card customers. The statements are designed to give cardholders a better perspective on the cost of using credit cards over the course of a year.

“We know from research that consumers aren’t lying around in bed at night worrying that they don’t have an annual credit card statement,” says Paul McCarron, the Cards Association’s head of cards and fraud control.

“What we do know is that when they receive one it will tell them a different story from their monthly statement.”

Another important factor, according to Rodford and McCarron, has been a change in the public’s perception of debt. The indebtedness of consumers became a focus of media attention in 2005 and 2006 leading to greater consumer caution over the use of credit, particularly from expensive sources like revolving credit on card products.

“It’s more about the way people see credit cards if you like. It’s about using credit cards wisely, not over-extending, and also a preference for debit cards.”

Pressure on margins

All of these factors have combined to put real pressure on the credit card industry. The £300 million in costs resulting from the regulations introduced will place further pressure on margins. All of the major revenue lines for credit cards – interest income, fees and charges, interchange, default fees and the sale of ancillary products (often payment protection insurance, another focus of regulatory pressure) – are under pressure.

The Cards Association estimates the average return on assets for credit card issuers is now between 1.5 and 3 per cent.

Optimists say that at least the worst should now be behind the industry after years of regulatory wrangling and waning consumer confidence. The number of zero per cent balance transfer offers increasing, indicating that issuers are keen to win new customers again.

Credit card spending for 2010 was £128 billion, its highest level ever. Bad debts are filtering their way out of the system. Increases in outstanding balances – and therefore revenue – may be just around the corner, according to Matthew Willman, a consultant at technology consultancy Global Card Solutions.

He accepts consumer appetite for borrowing on credit cards has fallen but believes a more important factor in the reduction of outstanding balances is the restriction of credit by lenders.

Citing Bank of England figures, he says credit card acceptance rates had “fallen through the floor” as a result of credit card companies introducing so-called deselection criteria – stricter lending rules which reduce the amount of successful credit applications.

“I think there will be a resurgence – there will be some level of confidence and consumer spending as people become more secure in their jobs, and that comes with a slight economic recovery,” he says.

“I don’t think our human nature has changed so much that we don’t want to buy now and pay tomorrow. Consumers are more cautious at the moment but at the same time the reason a lot of people aren’t spending on revolving credit is because credit institutions won’t lend them the money.

“Once the economy settles, organisations are going to start remembering that they used to make a huge amount of money lending to customers on a short-term basis on a revolving credit card. As soon as they start to believe they can do that safely again, that’s when they will start accepting more people.”

The industry’s resilience in the face of a consumer and regulatory backlash and poor economic conditions is a reason for optimism, according to Willman.

“It’s a bit like the old pendulum effect – the pendulum has swung onto ‘credit is bad’ at the moment,” he says.

“It will drift its way back to a more measured position which is actually ‘credit is useful’.”

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