by Will Dunning
Credit card lending is starting to look a lot like airline travel did a generation ago.
In those times, government regulations set minimum airfares at levels that would have allowed the airlines to be profitable. Since they weren’t allowed to compete on price, the airlines competed in other ways, including free food and drinks and service. To a large degree, they “competed away” their potential “excess profits.”
Now that airfares have been deregulated, prices are very competitive, but the perks have been reduced significantly. While consumers miss the freebies and often grumble about airline service, we have been made much better off by the advent of price competition.
In the credit card arena, lenders haven’t yet found a way to compete on price, so they follow a similar model of competing through other offerings. These include points, cash back schemes and insurance programs.
The credit card issuers behaviour is analogous to the airlines of earlier times. And, like the airlines, these perks have the effect of “competing away” some of the “excess profits” that might be earned in a market that is not competitive on pricing.
In fact, lenders have found another avenue for competing away the excess profits. This one, fortunately, was never adopted by the airlines — they are taking on added risk.
The Canadian Bankers Association reports that at the end of July, 1.05 per cent of credit card balances were delinquent by 90 days or more. This is more than 2.5 times the arrears rate for mortgages, which was 0.4 per cent at the same date. Indeed, if one were to track the arrears rate of both credit cards and mortgages, one would find that credit card arrears have been double that of mortgage arrears since 2004.
A further illustration of the riskiness of credit card lending is provided by the bankers association’s data showing that write-offs amounted to 3.91 per cent of total outstandings (at an annualized rate).
Some lenders are calling for increased regulation of mortgage lending. Mortgage lending is already quite highly regulated. In Canada, it is a quite safe form of lending as is illustrated by the arrears data from the Canadian Bankers Association. Indeed, the federal government has already made three sets of changes to its financial guarantee of mortgage insurance since 2008. The last series of changes resulted in a significant reduction in refinancings by Canadian households,
according to both CMHC and Genworth Financial.
If the lenders were writing-off their mortgages at the same rates as credit card balances (currently 3.91 per cent per year), it would be nothing short of catastrophic for the Canadian economy.
Strangely, though, lenders are not calling for increased regulation of credit card lending, an activity that is much less regulated, and is clearly much less competitive than mortgage lending and much more profitable.
(Will Dunning is an economic consultant who
specializes in analysis of housing markets.)