Mandelson barking up the wrong tree

Posted in 'Personal Finance' by Richard Catlin

08 December 2008

It seems that the Government's increasingly vocal attempts to coax credit card providers into being more responsible are based on poor knowledge of exactly how lenders make money from credit cards.

Business Secretary Peter Mandelson has told credit card companies that they will face an Office of Fair Trading investigation unless they reduce interest rates on credit cards. The APR on a number of cards has recently crept up in spite of the recent reductions in the Bank of England base rate.

Justified as a proposal to help consumers through the current financial crisis, it is unlikely to reap the required benefits. Any challenge by the OFT is likely to take many months to carry out and implement, as we saw with the investigation into the mis-selling of payment protection insurance. More importantly, even if the OFT forced credit card lenders to reduce interest rates, it’s likely that card issuers would simply recoup lost revenue through other means.

Revenue for credit card providers comes from two main sources at present – extended credit takers, (customers who don’t settle their bill in full each month, which is around half of us) and merchant service charges, charged to retailers for every card transaction.

Profits that card issuers make from these income streams are largely eaten up by losses in other areas. Section 75 of the Consumer Credit Act means that credit card companies are held jointly liable for consumer losses over £100 when a company goes bust and a credit card was used to make the purchase. In the current economic climate, where company failures are higher than usual, it’s likely that losses here will be much, much higher than usual.

Fraud losses are also currently absorbed by lenders on a voluntary basis - as long as the card holder isn’t deemed to have acted negligently. With identity theft and fraud levels constantly increasing, this is a big cost that the card companies aren’t legally obliged to pay.

So the upshot of any forced reduction to the interest rates that card providers charge (should it actually happen) would probably see the cost passed straight back onto the average consumer.

Very few credit cards in the UK carry an annual fee, but given the relatively small overall profit margins that card companies make, this would be unlikely to remain the case if interest rates were lowered. This is especially so given that card companies are still coming to terms with the huge reduction in revenue caused by the forced reduction in default charges.

Most UK cards offer an interest free period for ‘full payers’ that allows them to avoid being charged interest on new purchases. Again, this benefit could come under threat.

While card companies can do nothing about their obligation to Section 75, card issuers could change their approach to how they handle fraud losses, passing more responsibility onto the consumer, introduce annual fees and remove or reduce the interest free period that full payers enjoy.

A far better use of the Business Secretary’s time would have been to encourage consumers to vote with their feet and move to card providers that already charge much lower interest rates. You can check for free which lenders are matched to you on checkmyfile. Our research shows that the average UK consumer can save over £400 per annum by moving to cheaper lenders.

See if you could save money by switching cards