05 February 2008

Independent: Credit card misery

Two years ago, banks were desperately fighting for credit card market share. Now they are closing accounts. After years of easy money, Britain's credit card providers are having to face the harsh reality of a world that seems to be conspiring against them.

Fierce competition, rising bad debts, capital constraints, regulatory intervention and fears of economic slowdown are combining to make the outlook for credit cards a gloomy one.

The pressures on the industry have been highlighted by Egg, the online issuer bought last year by Citigroup of the US, which has decided to jettison about 7 per cent of its customers.

Egg says this is the result of a one-off credit risk review. But personal finance chatrooms are teeming with aggrieved customers who insist they are models of probity who repay their debts every month. They and others suspect they are being dumped because they are not profitable.

Egg insists this is not the case. But its decision to tell 161,000 customers they were no longer wanted has highlighted changes hitting the wider credit card industry. "It is very difficult for providers to make much cash," said David Black, principal banking consultant at Defaqto. "It is not a good business for them to be in at the moment because they are facing various threats to their income streams."

Even as Britain went on a spending binge amid a boom in cheap lending, credit cards were suffering from a loss of market share. Total UK credit card spending last year was £127bn. But purchases on credit cards barely increased from 2004's £123bn.

At the same time, spending on debit cards jumped to £225bn from £150bn as consumers made greater use of overdrafts to finance short-term borrowing. Some of this increase replaced cash and the slowly dying cheque, but debit cards have also hit their credit card rivals.

"Some consumers are unwilling to use credit cards because of a perception that they will get into more debt," said the Datamonitor analyst Kieran Hines. "Also, more consumers are used to using debit card for day-to-day payments and are using them for higher value purchases."

Many customers sitting on large chunks of equity in their homes have also consolidated their debts into secured loans to try to take control of their finances.

This loss of market share was accompanied by feverish competition as lenders cannibalised each other by offering 0 per cent deals to customers who switched provider. As the term "rate tart" entered common usage, lenders tried to put their houses in order by charging transfer fees, which started at about 2 per cent but are now creeping up towards 3 per cent.

But transfer fees have also discouraged use of cards. Steve Willey, head of credit cards at Moneysupermarket, said: "There is pressure around the fact that people are not using their cards as much. Balance transfer fees have been introduced and so people are not moving cards as often."

Faced with the credit crunch, increasingly overstretched consumers and an imminent economic slowdown, issuers are cracking down on default risk. Barclaycard, the country's oldest and biggest credit card provider, said it was not following Egg in shutting accounts but that it has reduced credit limits and restricted access to cash withdrawals if credit data show customers getting overstretched.

Barclaycard is also homing in on dormant accounts by writing to inactive customers but it said they were allowed to keep their cards if so desired.

Barclaycard turns away half of the applicants it receives. Though that headline figure has remained constant, it says rejections have risen in recent months as potential borrowers have faced increased strain.

At the same time, the industry has been hit by a slew of regulatory clampdowns that have reduced profitability. In 2006 the Office of Fair Trading reduced the maximum penalty fee from at least £20 to £12 for most lenders to bring the penalty closer to the cost to the company. Personal protection insurance, a high-margin product sold along with credit cards, also faces an inquiry by the Competition Commission and claims for refunds from unhappy consumers. And the European Commission is also clamping down on interchange fees charged to merchants who take credit card payments.

Another regulatory pressure comes from the arcane Basel 2 capital accord, which redraws the way lenders calculate the buffer they need against defaults. While the rules reduce the percentage of an outstanding loan that issuers have to keep on their balance sheets, unused credit limits now consume more capital than they did under the previous regime. This encourages lenders to tighten up on limits and to be more selective about customers.

Lenders are also facing higher funding costs after the cheap wholesale debt they used to finance their lending in the credit boom disappears. The Bank of England's survey of credit conditions has shown that the credit crunch is already eating into the amount of credit made available to households.

Borrowers who took advantage of easy credit are being hit by higher interest rates as well as rising council tax bills, fuel bills and other costs. Credit card bad debts rose to £2.8bn in 2006 from £1.1bn in 2002, Bank of England figures show. Bad debts are a fact of life for banks and other lenders, but the severity of the credit crunch makes risks hard to quantify.

Even customers who repay every month can become risky if they get into trouble with other lenders or their circumstances change. With fears of a sharp economic slowdown or even a recession increasing, lenders have to prepare for customers losing their jobs. That could put sudden pressure onto their finances.

Neil Munroe, external affairs director at Equifax, said: "It is not a fixed-term loan. There is a limit and people have the ability to move into those limits pretty quickly. Issuers are making judgments that people who were marginally good risks are now marginally bad risks."

Mr Munroe said issuers want to keep lending but that competition will now be for the best customers. Lenders will also be monitoring customers' behaviour like hawks to try to make sure they are the first in the pecking order for repayment if customers get into trouble.

In a market that is harder for everyone, the difference between the winners and the losers will be a stark one for issuers and customers alike.

By Sean Farrell

© The Independent