When Bernie Sanders and Donald Trump agree on something, it’s a sign that trouble is afoot. And recently, the senator from Vermont said that he would gladly work with the president-elect to cap credit card interest rates at 10%, a promise Trump made during the campaign.
Their complaint is simple: Americans who have to pay 20% or 30% interest on their credit card debt are being ripped off. Those rates do sound unjust, but imposing a cap would just make things worse – for borrowers more so than banks.
Consider the industry’s background. Competition among credit card issuers in the U.S. is intense. A large number of banks and fintech companies offer cards, which compete along many dimensions – annual fees, payment services and options, travel rewards and points, and of course borrowing rates. If a consumer does not like these terms, they can go elsewhere. One recent survey counts 643 credit cards from 156 issuers.
With so many different suppliers, it is likely that the offered terms of trade reflect the costs of production – in this case, the costs of expected default or delayed payment. Currently the total of revolving balances is estimated at $628.6 billion, which is 71.3% of outstanding balances. Average debt per borrower is more than $6,300, and delinquency rates have reached 3.3%.
In other words: A lot of payments are not being made promptly. This is a major cost to card issuers. One explanation for interest rates of 20% to 30% is that they are needed to compensate for all these delayed and defaulted payments.