While a recent U.S. threat to cap the interest rates charged on credit cards remains speculative, the actual imposition of such a limit would shake up the financial industry, says Morningstar DBRS Inc.
Last week, on social media, the U.S. president called for a 10% cap on credit card interest rates, starting Jan. 20.
At this point, the idea remains fanciful — given that it hasn’t been made clear how this would be implemented, and any executive order aimed at setting credit card rates would likely face legal challenges. Even so, the suggestion has rattled investors.
In a research note, DBRS said that with the prevailing interest rate on credit cards averaging around 22.3%, a cap at 10% implies that interest-based revenues could drop by more than 50%.
“We expect any potential cap on credit card interest rates would have adverse ramifications on card issuers’ profitability over the near term, particularly for card issuers with higher exposures to riskier segments of the credit spectrum that typically have higher effective interest rates and revolve more,” DBRS said in a research note.
Riskier credit card holders typically face higher rates, given the expectation that they will produce higher credit losses — so riskier segments would likely be most affected by a cap on rates, the report said.
This could, in turn, lead to a variety of other changes to companies’ operations to compensate for the expected loss of interest-driven revenues.
“… credit card issuers are likely to significantly alter their underwriting standards, risk-adjusted pricing, rewards offerings and portfolio management strategies, the report said — adding that this could also lead to issuers reducing, or cancelling, the provision of credit to riskier cardholders, and to imposing higher fees on cardholders, to offset the lost revenue.
“As a result, the competition in the credit card sector is likely to intensify further for these segments, while certain card issuers may divest or shrink their credit card portfolios if they fail to adapt to the evolving industry landscape,” it said.
At the same time, a cap on rates, “would likely force these riskier borrowers to seek even more expensive access to credit or to cut back on spending,” DBRS said, which could weigh on economic growth, given that, “any decrease in credit availability hurts the overall economy.”
Indeed, banking industry lobbyists in the U.S. warn that capping rates would harm borrowers and the economy.
“If enacted, this cap would only drive consumers toward less regulated, more costly alternatives,” said industry lobby groups — including the Bank Policy Institute, American Bankers Association, Consumer Bankers Association, Financial Services Forum and Independent Community Bankers of America — in a joint statement.
“… evidence shows that a 10% interest rate cap would reduce credit availability and be devastating for millions of American families and small business owners who rely on and value their credit cards, the very consumers this proposal intends to help,” it added.