Credit card roulette

will dunning

From Thursday’s Globe and Mail

Published Thursday, Dec. 29, 2011 2:00AM EST

Credit card lending is starting to look a lot like airline travel did a generation ago.

In those times, government regulations set minimum airfares, at levels that would have allowed the airlines to be very profitable. Since they weren’t allowed to compete on price, airlines competed in other ways, including free food and drinks, and service. To a large degree, they “competed away” their potential “excess profits.”

Now that airfares have been deregulated, prices are very competitive, but the perks have been reduced significantly. While consumers miss the freebies, and we often grumble about airline service, we have been made much better off by the advent of price competition.

In the credit card arena, lenders haven’t yet found a way to compete on price, so they follow a similar model of competing through other offerings. These include points, cash-back schemes, and insurance programs. The credit card issuers’ behaviour is analogous to the airlines of earlier times. And, like the airlines, these perks have the effect of “competing away” some of the “excess profits” that might be earned in a market that’s not competitive on pricing.

In fact, lenders have found another avenue for competing away the excess profits. This one, fortunately, was never adopted by the airlines: They’re taking on added risk.

The Canadian Bankers Association reports that, at the end of July, 1.05 per cent of Visa and MasterCard balances were delinquent by 90 days or more. This is more than 2.5 times the arrears rate for mortgages, which was 0.40 per cent at the same date. Indeed, if one were to track the arrears rate of both credit cards and mortgages, one would find that, since 2004, credit card arrears have been triple that of mortgage arrears.

Further illustration of the riskiness of credit card lending is provided by the CBA’s data showing that write-offs at the end of July amounted to 3.91 per cent of total outstanding balances (at an annualized rate).

Some lenders are calling for increased regulation of mortgage lending. Mortgage lending is already quite highly regulated and, in Canada, is a quite safe form of lending, as illustrated by the CBA arrears data. Indeed, the federal government has already made three sets of changes to its financial guarantee of mortgage insurance since 2008. The last series of changes resulted in a significant reduction in refinancings by Canadian households, according to mortgage default insurers, including CMHC and Genworth Financial Canada.

If lenders were writing off their mortgages at the same rates as credit card balances (currently 3.91 per cent a year), it would be nothing short of catastrophic for them and for the Canadian economy.

Strangely, though, credit card issuers aren’t calling for increased regulation of credit card lending – an activity that’s much less regulated and much less competitive than mortgage lending, and is more profitable.

Will Dunning is an economic consultant who specializes in analyzing housing markets.