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Do consumers really want credit card reform?
Federal Reserve Bank of Kansas City - Economic Review, Third Quarter 1999 by Combs, Kathryn L, Schreft, Stacey L
When issuers can circumvent the restriction
A fee cap need not be beneficial-or even neutral-in its impact on consumers when issuers can adjust the unrestricted price and nonprice card features that make up the effective price. It is very likely that issuers will want higher interchange rates if prohibited from charging a GE fee since issuers' major source of revenue from convenience users is interchange fees. As already discussed, this can result in higher prices to all consumers.
Similarly, issuers could react to a fee cap by increasing other fees, such as annual fees and late payment fees. These fee increases would have to apply to all customers because the cap prohibits fee adjustments applied only to convenience users. If the fees are increased, then some of the cost of supplying convenience users is passed on to revolvers. Convenience users, however, might not be willing to pay higher annual and other fees; they might, instead, prefer to switch to alternative means of payment.
This analysis suggests that issuers have an incentive to expand and better differentiate their product lines in the hope of increasing their market power and thus their ability to charge higher fees. Customers can be offered upgrades to new card products that provide a wider range of free services in exchange for a higher annual fee. Such efforts at product differentiation are likely to be observed in both market segments. But since issuers have relatively more market power in the revolving-loan market than in the convenience-use market, these efforts are qualitatively less important for the analysis of APR caps.
The conclusion is that when issuers can adjust the unrestricted components of effective price, a prohibition of a GE fee generally perpetuates or induces a transfer of wealth from those who are not pure-convenience users to those who are. Whether this wealth transfer is desirable is a political question, not an economic question.
When issuers cannot circumvent the restriction
When issuers cannot make sufficient adjustments in the unrestricted card terms, the effective price to convenience users under the fee cap is below what it would be with a GE fee. More consumers demand cards for convenience use at the lower effective price. If issuers' motivation for imposing the fee was to cover the increased cost of supplying convenience users, the demand for cards for convenience use is higher than they desire. And as before, issuers are likely to engage in credit rationing by supplying fewer convenience cards by reducing or even eliminating the grace period on outstanding cards. This makes convenience users more profitable by turning them into revolvers. Card cancellation is another likely rationing method. Customers who charge a low dollar volume of purchases and thus who generate little interchange-fee revenue are the most likely to experience this practice. In the extreme case, issuers cease operation because they cannot earn an adequate return supplying the market segment. Either approach drives some convenience users to switch to using cash or checks for a larger share of their purchases. If convenience users were making their most preferred mix of cash, check, convenience credit card, and revolving credit purchases before the GE cap was imposed, which is reasonable to assume, then they are harmed by the cap.
