The Profitability of Credit Card Banks

Since 1988 the Federal Reserve Board (FRB) has been required by Congress to report annually on the profitability of the credit card operations of depository institutions. The report for the year 2000 was released by the FRB last June. It reveals some interesting trends that highlight the competitive nature of the credit card market.

The FRB bases its analysis on Call Report data which every insured commercial bank must file each quarter. Call Report data provide a comprehensive balance sheet and income statement for each reporting bank, but does not allocate expenses or attribute revenues to specific product lines such as credit cards. Consequently, to generate its report to Congress the FRB focuses on those banks established primarily to issue and service credit card accounts. These institutions are identified by two criteria: (1) the bulk of their assets are loans to individuals (consumer lending), and (2) 90 percent or more of their consumer lending involves credit cards or related plans. In addition, the FRB examines only those credit card banks having at least $200 million in assets.

As of December 31, 2000, 28 banks with assets exceeding $200 million qualified as credit card banks under the definition above. These banks accounted for 72 percent of outstanding credit card balances on the books of commercial banks or in securitized pools. The return on assets (net earnings before taxes as a percent of outstandings) for this group of banks in 2000 was 3.14 percent. The chart below displays the return on assets (ROA) for credit card banks over the past 15 years. Profitability in 2000 was down slightly from 1999, but still compared favorably to the levels of the mid-1990s. Significantly, the profitability of credit card banks is substantially higher than the ROA for all commercial bank activities, which was 1.81 percent in 2000. This is expected since credit card banks specialize in a higher-risk, unsecured type of loan.

The FRB report found that the declining profitability in 2000, relative to 1999, was due primarily to credit quality problems, which prompted banks to increase their reserves for future loan losses. Provisions for future losses increased 5 percent from the 1999 levels. Overall expenses per dollar of assets also increased. Interest expenses rose 19 percent from 1999, while non-interest expenses increased only 2 percent. Revenues also rose. Interest income as a percent of assets increased by 6 percent and non-interest income increased about 1 percent.

The report also notes that "Prior to the early 1990s, card issuers competed primarily by waiving annual fees and providing credit card program enhancements. Since then, however, interest rate competition has played a much more prominent role. Many credit card issuers, including nearly all of the largest issuers, have lowered interest rates on many of their accounts below the 18 to 19 percent levels commonly maintained through most of the 1980s and early 1990s. Credit card interest rates in general have become more responsive to issuers' cost of funds in recent years as more issuers have tied their interest rates directly to one of several indexes that move with market rates (currently about three-fifths of card issuers tie their interest rates on their largest credit card plans to a market index)."

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