
                         Roanoke Times
                 Copyright (c) 1995, Landmark Communications, Inc.

DATE: SUNDAY, April 21, 1991                   TAG: 9104180529
SECTION: BUSINESS                    PAGE: E-1   EDITION: METRO 
SOURCE: By JOHN M. BERRY and ALBERT B. CRENSHAW/ THE WASHINGTON POST
DATELINE:                                 LENGTH: Medium

WHY WE'RE HELPING TO KEEP CREDIT CARD RATES HIGH

To all outward appearances, the credit card marketplace is a model of vigorous competition. Some 4,000 banks and other companies issue more than 250 million credit cards. Issuers vie fiercely for new business, spending millions of dollars to lure customers into the fold.

But if the market is so competitive, why do credit card interest rates remain at 18 percent or more in the face of an overall decline in interest rates for other types of borrowing?

The answer, according to a growing number of market experts, is that many people who have credit cards don't do what they say they are going to do: pay off the card balance before a month is up, avoiding hefty interest charges. The result is that the issuer racks up a big profit and gets a signal that the card holder doesn't really care about the interest rate.

This indifference, according to a recent study, is costing American users of credit cards $6 billion a year.

It seems "the marketplace doesn't work very well," said Stephen Brobeck of the Consumer Federation of America, which earlier this month released a study showing a widening gap between what banks pay consumers for their deposits and what they charge for credit cards and other personal loans.

If consumers were more conscious of the rates they were paying on their credit cards and shifted their business to issuers with the lowest rates, then there would be more of an inducement for the card issuers to lower rates as a way of attracting customers.

Brobeck called on banks to lower rates, but he conceded that people all too often make themselves vulnerable to high finance charges by promising themselves that they will pay in full and then not doing so.

A new study by a Northwestern University business school professor comes to the same conclusion.

The professor, Lawrence Ausubel, surveyed major banks issuing credit cards and found that only about a quarter of the accounts actually get paid off each month. In contrast, he noted, consumer surveys by the University of Michigan showed that nearly half of all families said they "nearly always pay in full," and another fourth said they "sometimes pay in full." Only one-fourth said they "hardly ever pay in full."

In a paper published last month in the American Economic Review, Ausubel uses this difference between what consumers say they do and what they actually do as the foundation for an intriguing explanation of why the apparently highly competitive credit card market is so lucrative for banks.

Consumer indifference to credit card interest allows banks to charge rates roughly 5 percentage points higher than they could if the market behaved in competitive fashion, Ausubel calculated. In other words, instead of having rates generally ranging from 17 percent to 22 percent, they would be 12 percent to 17 percent.

With average account balances well over $1,000 and rising, and total outstanding bank credit card debt of more than $120 billion, the higher rates cost consumers about $6 billion annually, if Ausubel's estimate is correct.

The lack of consumer concern about interest rates is underscored by the pitch that banks make regularly in their direct mail appeals to potential new card holders. For instance, an appeal sent last week by Colonial National Bank of Delaware touting its gold MasterCard highlighted its lack of an annual fee, a $6,000 credit line, free additional cards, automatic travel insurance, instant cash access at thousands of automatic teller machines and a 25-day grace period in which to pay the bill.

As with most card mailings, information on the interest rate on unpaid balances was found in a legally required disclosure, in smaller print. In this case, the annual rate was 17.95 percent for the rest of this year, and after that 9.95 percentage points above the prime lending rate, which is currently 9 percent. If the prime rate were 10 percent during 1992, the rate on the card would be 19.95 percent.

"The experience of credit card marketers is that consumers are much more sensitive to increases in the annual fee than to increases in the interest rate, despite the fact that the majority of card holders pay significant finance charges," Ausubel wrote in the American Economic Review.

by CNB