Why are Banks Bribing Some Credit Card Holders?

Banks and financial institutions which issue credit cards to their customers make money in two ways. The first is through the subscription charges paid annually for one to own a card while the second is by charging interest on the balance on the card itself. As competition got more intense, the banks wiped away the subscription charges and came to rely primarily on the interest income. This situation led to the often stated fact that most working US citizens were being bombarded with credit cards for which they had not made applications but which a significant number took up to maintain the consumption that characterized recent years.

James Surowiecki's piece in the New Yorker states that banks are now faced with the real chance of defaults on credit card debt on account of the state of the economy. In this instance then, the financial institutions find that it is important to identify the customer who is most likely to default on a loan and cut him off and reduce that risk of default. As the story states, that is not so easy because the profit model for the banks is to find a spendthrift who uses the cards intensely while paying only the minimum payment on the balance. This category of customer is difficult to shed without affecting profits because a majority of interest income is gained from the rolling over of debt. This presents a dilemma because shedding off this customer could affect future profits because the safer category of customer would probably pay the entire balance on time and thereby earn the bank little or no interest fees.

So it appears that the economic crisis and the recession is not only leading to the questioning of the models of profits that were designed by hedge funds but it is also asking for the re-examination of the structure of the credit card markets. This is especially poignant for me because I just finished reading Dan Ariely's book, Predictably Irrational a couple of months ago. One of the best chapters in there was the solution that he designed in the quest to assist banks to reduce credit card misuse but which was rejected or ignored at a meeting with one bank. To my mind, while I found the proposals slightly paternalistic hence objectionable, that the bank dismissed it off-hand was a manifestation of short sightedness. It is even more surprising now that one bank is having to provide a US$ 300 inducement for clients to close their accounts. This realization makes the title of the article quite apt in reference to some of the banks.