Competition in the credit card industry

Phil asks:

Could you further explain how the change in change in bankruptcy laws would only result in a "temporary profit spike for credit card issuers?"

Sure. The credit card industry features a large number of competitors with little product differentiation (every Visa card does the same thing). Barriers to entry are low—as far as I understand it, any bank can issue a Visa card, and there are thousands of banks in the United States. The result is intense competition between firms and low profits.

I suspect that credit card issuers lose quite a bit of money for every new cardholder they obtain. This is the cost of marketing in a highly competitive market. They then hope to make the money back when the cardholder uses the credit card as a loan and pays interest on his balance. They also hope he will make late payments so he can be socked with the big late payment fees (as high as $39).

So you see, the main reason why credit card issuers aren’t making as much money as they would like is not because of bankruptcy laws, but because there is so much competition. After bankcrupty reform, profits will increase if the card issuers maintain their same business practices. But they won’t, because with each new account now being more profitable than before, more money will be spent trying to obtain new cardholders, driving down profits to where they are now.

Comments

[tom f]

At least one of the analysts at Bankstocks.com basically agree with you. There is also an increasing investor skepticism of the quality of earnings of aggressive lenders like Capital One that "...exist not to supply credit that can be paid back on time, but to supply credit that can't."