The Impact the Credit Crunch is having on the Credit Card Industry
Date: 15 Apr 2008
by Paul Rogers
Every time you pick up a newspaper, listen to the radio or switch on the TV, sooner or later, usually sooner the words ‘credit crunch’ appear. When interviewed, financial analysts constantly refer to ‘the credit crunch’ whilst the interviewer, and if there is one, the panel of experts nod wisely. But does the average man and woman in the street know what the credit crunch means to them. What impact on their finances will it have? How will it affect them regarding their credit cards?
It all began in America about eighteen months ago when the mortgage sellers decided to target the more risky or sub prime market. This led to very many mortgages being sold to people with bad credit history, low incomes, insecure employment etc.
It does not take a financial genius to figure out what happened next, these people were unable to make the repayments. At the same time US falling house prices and higher interests led to a dramatic rise in repossessed property.
The question is of course, ‘If it all started in the United States of America, why is it affecting me in the UK?’ In the mid nineteen nineties the financial wiz kids in the USA and later the UK worked out that it was far cheaper to borrow money from each other (i.e., commercial banks and institutions) rather than from their own central bank. This gave rise to US banks selling mortgages that they had issued to the US public including the sub prime mortgages to other banks in the US and around the world including the UK, whose banks and other financial institutions bought quite a lot.
It does not take a financial genius to figure out what happened next, these people were unable to make the repayments. At the same time US falling house prices and higher interests led to a dramatic rise in repossessed property.
The question is of course, ‘If it all started in the United States of America, why is it affecting me in the UK?’ In the mid nineteen nineties the financial wiz kids in the USA and later the UK worked out that it was far cheaper to borrow money from each other (i.e., commercial banks and institutions) rather than from their own central bank. This gave rise to US banks selling mortgages that they had issued to the US public including the sub prime mortgages to other banks in the US and around the world including the UK, whose banks and other financial institutions bought quite a lot.
These mortgages have been sold on and on and on to banks all over the world and because tied up with these mortgages were the so called ‘sub prime mortgages’, the commercial banks of the world have no idea what part of the mortgage business that they have bought, contains sub prime mortgages. What they also don’t know is in what way other commercial banks around the world have been affected and how much mortgage business that they have bought, contains sub prime mortgages. The outcome of all this is that banks around the world do not trust each other and therefore do not want to lend each other any money. This has the knock on effect of creating a major shortage of money within the banking community, such that the banks cannot or will not provide the credit facilities that they did two years ago. In other words, the financial world is experiencing a credit crunch.
All well and good I hear you say, but how exactly does this so called credit crunch affect me? Well, now that the financial institutions of the world have lost faith with each other, they are no longer lending any money (or very little money) to each other and this in turn creates a global problem. The world’s stock markets are falling which impacts on our pensions and investments. The commercial banks and financial institutions need more money to conduct their day to day business of lending money, and as borrowing from other commercial banks has stopped, the only way for them to get money in is by raising interest rates on existing mortgages, credit cards and loans. It would appear that the days of easy credit and the ‘live now pay later’ lifestyle is coming to an end.
Still with me? OK, let’s look at what effect the credit crunch is having on the credit card industry in the UK. Up until early last year the previous ten years were a boom time for the credit card companies in the UK, but with the arrival of the credit crunch, coupled with extreme competition, an economic downturn, increasing bad debts, and government regulations have made the credit card companies reevaluate their position.
An example of this is Egg, the online issuer of credit cards who were bought last year by City Group. Egg has decided to release about seven percent of its customers. Egg says that the release of customers was due to a credit risk review, however, the word in the financial chat rooms is that many of the customers that Egg released were those who paid off their outstanding debt every month. The word is that Egg effectively dumped these customers because they were not profitable.
Egg insists that this is not the reason, but the dropping of over one hundred and sixty thousand customers by Egg shows the changes of position the credit card providers are taking. Credit card customers who pay off their balance every month may be a safe bet, but they are not very profitable to the credit card issuer.
Barclaycard, probably the most well known credit card provider in the UK, said it will not follow Egg by ‘losing accounts’, but is reducing credit limits and restricting access to cash withdrawals to those customers whose credit data shows them getting overstretched.
Barclaycard is also writing to those customers that appear to have inactive accounts, although they said that they would allow customers to keep their cards if they wanted to.
Barclaycard is also writing to those customers that appear to have inactive accounts, although they said that they would allow customers to keep their cards if they wanted to.
Even when the UK was on a spending spree due to low cost credit, credit cards were already starting to suffer from a loss of market share. Last year the total UK credit card spending was 127bn GBP, which was only 4bn GBP more than in 2004.
On the other hand, debit cards rocketed from 150bn GBP in 2004 to 225bn GBP in 2007 mainly due to consumers making more use of overdrafts to pay for short term borrowing.
Part of this increase was due to the decline in the usage of the cheque book and cash, but another part of it was at the expense of the credit card industry.
Part of this increase was due to the decline in the usage of the cheque book and cash, but another part of it was at the expense of the credit card industry.
Many credit card customers who are house owners with a fair amount of equity attached to them have refinanced and taken out secured loans to pay off their credit debts, in a move to attempt to once again take control of their finances.
The credit card industry has been hit by a double whammy, on the one hand the loss of overall market share resulted in fierce competition as lenders attacked each other with offers of zero percent transfer charges to customers who switched providers. Nowadays the credit card companies are once again charging transfer fees of around two and a half percent which is slowly moving towards and beyond three percent. This has the adverse effect of discouraging people from changing provider.
The second problem the credit card industry faces is that of regulatory measures that have impacted on their profitability. In 2006 OFTL (Office of Fair Trading) reduced the maximum penalty fee from at least 20.00 GBP down to 12.00 GBP and the EU is looking at ways to reduce the interchange fees charged to merchants who accept credit cards. The personal protection insurance that is often bundled with credit cards is also under investigation by the Competition Commission. The credit card companies now have to face up to the higher costs when funding their day to day business, as the source of cheap wholesale debt they have been using has dried up due to the credit crunch.
The second problem the credit card industry faces is that of regulatory measures that have impacted on their profitability. In 2006 OFTL (Office of Fair Trading) reduced the maximum penalty fee from at least 20.00 GBP down to 12.00 GBP and the EU is looking at ways to reduce the interchange fees charged to merchants who accept credit cards. The personal protection insurance that is often bundled with credit cards is also under investigation by the Competition Commission. The credit card companies now have to face up to the higher costs when funding their day to day business, as the source of cheap wholesale debt they have been using has dried up due to the credit crunch.
Those of us who took advantage of low cost credit, are now having to face the prospect of higher credit rates along with the rise in other living expenses. The amount of credit card bad debts rose from 1.1bn GBP in 2002 to 2.8bn GBP in 2006 according to Bank of England figures. Although there will always be bad debts for banks and other financial institutions, the impact of the credit crunch makes it hard to evaluate the risks.
Even customers who repay every month could be a potential risk if their circumstances change. The possibility of an economic slowdown or even a recession makes it a possibility that some customers will lose their jobs, putting a heavy burden on their finances. The Credit card issuers now have to evaluate the risk associated with every customer and the issuers will be keeping a sharp eye on their customers to make sure that at the first sign of any financial difficulty, the issuer will be the first to receive any repayment due. Although issuers want to keep lending, they will only lend to those who they perceive as being the safest risk.
If after reading all that doom and gloom, you still wish to use a credit card, then there are a number of ways you can take advantage on what is on offer in the marketplace.
What Credit card is the best for me?
I have set out three scenarios regarding credit histories.
- Your credit score is good but you have an outstanding balance. If you have been a good boy or girl and have never missed a payment or gone over your agreed limit, then you should have acquired a very good credit score and therefore you should be able to take advantage of one of the zero percentage balance transfer deals that are on offer in the UK. The fee to move your balance from one credit card to another will be up to three percent, but this is a small price to pay if in return you receive a long interest free period on your existing balance, which will enable you to clear your debt. Even if you don’t manage to pay off the outstanding debt in full during the interest free period, you could transfer it again to another zero percent offer once the introductory period expires.
- You always pay the balance every month and have a good credit rating. Even more of a boy scout (dib dib dib) are those of us who choose to pay off the balance of our credit card every month. In this instance there is no benefit in having a credit card that has a low rate of interest on the outstanding balance. Instead look for a credit card that offers a loyalty scheme or plan that gives the credit card user reward points to exchange for goods or services. Alternatively other credit card issuers offer cash back as an incentive, and there are many good offers on the market. So with due diligence, check them out so as to find the right deal to suit you.
- For those of us who haven’t exactly been an angel. Even though your credit rating is not what it could be, there are still a number of choices open to you. Again due diligence is needed as you will have to take care what type of card you apply for. You have no chance with the eye catching deals on offer. Don’t bother applying as you will almost certainly be refused and refusals do not help your credit score. What you will be offered is an interest rate that is higher than the norm, but if you use and not abuse the card and stay within your limit, your credit rating will improve thus allowing you to get a better deal on a credit card further down the road.
In the words of JFK (with poetic license)
To slightly change the words of his famous speech “Do not think what you can do with your credit card but what your credit card can do for you.”
