Credit Card Banking

Credit card interest rates currently average 22%, an 18% spread over the short rate. This spread far exceeds that on any other loan or bond, yet nearly half of households are credit card borrowers. Why are credit card rates so high? To understand this, and the economics of credit card banking, we use regulatory account-level data to analyze the lifetime cash flows of 550 million monthly accounts, representing 90% of the US credit card market. While charge-off rates are comparatively high, averaging around 6%, they explain only a fraction of cards' spread. Reward payments and non-interest expenses are more than offset by interchange and non-interest income. Operating expenses, particularly marketing, are very large, and are used to generate pricing power. Yet, after deducting them, card lending still earns a 6.8% return on assets (ROA), more than four times the banking sector's ROA. Using the cross section of accounts, we estimate that credit card rates price in a 4.3% default risk premium, similar to high-yield bonds. Accounting for this, card lending earns an alpha of around 1.5% relative to the aggregate bank sector.