By Ray Birch
PETERBOROUGH, N.H.—The Federal Reserve’s ongoing rate hikes could ultimately push credit unions out of the credit card rewards battle, resulting in many of their cardholding members taking their balances and business to other issuers, a new analysis suggests.
“Credit unions’ mandatory 18% rate cap has become a material constraint on CUs’ abilities to compete with large banks in the rewards space,” said Tim Kolk, principal at TRK Advisors, who noted the problem has become magnified by the Fed’s efforts to push up rates. “It’s like credit unions are trying to compete with one arm tied behind their backs.”
All federally chartered credit unions have an 18% interest rate cap across the board. Some state-chartered credit unions have other caps, at various levels, noted Kolk.
A ‘Relevant’ Issue
“They can't charge an interest rate over 18%, which is most relevant on credit cards,” said Kolk. “The reason it's most relevant is the average APR on credit card revolving interest, as of May, was 22.2%. That means the average APR on a credit card that's (charging) interest in the United States is 416 basis points above the 18% cap.”
Obviously, that means credit unions are prevented from charging rates at market levels, said Kolk.
“Keep in mind the average is 22.2%, which means rates range much higher than that for many folks who use credit cards to revolve balances,” Kolk said.
That leads to some competitive problems, he said. The first is credit unions cannot help some members with a lower-rate card that reduces the interest they’re paying a big bank.
Difficult Scenario
“Let’s say a member has a 27% card at a big bank and the credit union knows it can improve the member’s monthly balance sheet with a lower-rate credit card,” said Kolk. “But, the borrower is too risky to give them an 18% rate. They CU can, risk based, give them a better rate than the bank—maybe 21% to 22%--but is prohibited from doing so by NCUA. The member, who needs help from their credit union, is turned away. The member would certainly be better off at the credit union, and the CU would be happy to help them and charge the rate they need to charge, but they can’t.”
There is an entire segment of credit card users CUs cannot serve well as rates have risen, Kolk posited.
The Second Problem
“The second problem is credit card rates are as high as they are because many consumers that revolve a balance prefer rewards points, or cash back, more than a lower rate,” explained Kolk. “Maybe that’s not the best rationale, but that's what consumers have proven they prefer—some combination of value different than rate—rewards or promotional points, things like that. When a bank can charge on average 22%, and a credit union can charge at most 18%, banks can earn more on interest and in the competitive world that means they can afford to pay higher levels of reward value than credit unions.”
Kolk insisted it will be hard for credit unions to be competitive players in the rewards space, or even credit card space overall, for that matter, if they can’t charge an interest rate to offer a competitive rewards program.
Tim Kolk
And, as CUToday.info has been reporting, if the Credit Card Competition Act is passed by Congress, that battle will get even tougher.
‘Bad for the Movement’
“They have a very hard time offering rewards value that is at market levels, and therefore their members choose a big bank credit card with higher rewards,” Kolk said. “That also is bad for the credit union movement, because every time a member finds a product in a non-credit union financial institution the risk of the relationship being poached increases.”
Kolk said he does understand why the 18% rate is in place, but it’s purpose is no longer relevant. As CUToday.info reported, the NCUA board recently approved extending the 18% cap for another 18 months.
“The 18% rate cap at first blush might be considered a reasonable thing to do to protect credit union members,” he said. “However, it denies some members the ability to get credit cards from their credit union they would likely prefer, and it impairs credit unions’ abilities to compete on the rewards front.”
Magnifying the Issue
The Fed’s rapid rate hikes over the last two years have magnified the issues, explained Kolk.
“With prime at 8.25%, the rate cap effects every credit card,” Kolk said. “Every regulated credit card is at prime plus 9.75%, which bumps up on that rate ceiling. Virtually all credit unions’ cards are now at the cap.”
Kolk pointed to date that indicate what is happening—banks are winning more cardholders and balances as CUs lose share.
“Credit unions’ card portfolios had been outgrowing banks’ portfolios every year from 2005 to 2020. From 2021 through 2022, credit unions did not lose ground to banks, but they only remained level with them,” Kolk said.
‘It’s Very Clear’
But at the start of 2023, in Q1, banks grew by 2% while credit unions remained flat.
“So, it is very clear in the data, something is holding credit unions back in the credit card market, and, in my opinion, it is the 18% rate cap,” said Kolk. “If this trend continues, what was long a credit union advantage could become a big problem.”