Maybe a good deal for you; definitely a good deal for credit card companies.  UK regulators are concerned about zero interest introductory cards.  Thanks to the wonders of accrual accounting, those zero percent offers to consumers set off accrual revenue for card issuers who model that the account will remain open after the zero percent rate expires.

  • …how banks account for interest earned on zero percent balance cards, which attract consumers with sometimes long initial interest-free periods, is worrying some. Britain’s Prudential Regulation Authority warned that if banks are wrong about how customers will behave it could hit their capital.
  • Banks start booking interest income immediately after issuing the card, even though some customers may not pay any for years and could switch banks at the end of the interest-free period, before rates that can be as high as 20% kick in.
  • “The issue with this is it’s really, really subjective, because ultimately there are so many assumptions,” a fund manager at a top-10 investor in some of Britain’s biggest banks said.

The credit card model, both for branded and closed networks is undergoing stress.  Will reductions in rewards begin to offset non-interest revenue challenges.

  • Under international accounting rules, banks predict how much income the card will earn in total, and then spread this out equally over the years they expect it to be active.
  • Forecasts are based on assumptions the banks set themselves, including how many customers they think will continue to use the cards after the interest-free period ends and for how long.

The UK market is struggling with £70 billion in consumer credit card debt, and though delinquencies are starting to pop, accrual accounting keeps revenue steady.

  • Virgin Money books the interest income for its cards at a rate of 6.8% a year, assuming that more than 40% of its customers will move to higher interest rates and use the card for a maximum of seven years in total.
  • While interest-free periods offered by banks have dropped back from a 43-month high in 2017, the fee charged for transferring debts onto a new card has now fallen to its lowest since 2006, Moneyfacts data shows.

Here’s the catch, similar to what we mentioned about the sustainability of credit card rewards. All this accounting sounds great if consumer performance matches the business model, the estimates will work correctly.  If cardholder attrition is high, the term will not meet the model and revenue will fall short.

Free is rarely free!

Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group

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