Academic journal article Academy of Banking Studies Journal

The Behavior of Credit Card Interest Rates during the Decline in Other Interest-Rate Markets

Academic journal article Academy of Banking Studies Journal

The Behavior of Credit Card Interest Rates during the Decline in Other Interest-Rate Markets

Article excerpt

INTRODUCTION

Although some consider 1949 to be the approximate beginning of the modern credit-card era (Brooker, 2004), the genesis of this powerful social phenomenon certainly goes back at least to the early 1900s. In 1914, for example, Western Union was using metal cards to allow its best customers to defer payments, and the cards became known as "Metal Money" (ETI, 2003). Prior to World War II it was fairly common for "department stores, communication companies, travel and delivery companies, and oil companies" (ETI, 2003) to issue credit cards to encourage and facilitate the purchases of their own products. But generally the cards were for "local purchases" at a single location and rarely used for the products of other companies.

During World War II the use of credit cards was prohibited, but the practice re-emerged following the war as customers discovered the "beauties of enjoying now and paying later." In approximately 1949 the Diner's Club card was instituted and allowed "travel and entertainment people" to use one card to charge purchases from many retailers. The success of this "one card for many businesses" encouraged others, and in 1951 the Franklin National Bank in New York issued the "Charge It" card (ETI, 2003). This was really the period of time when the idea was established of financial intermediaries handling credit card processes for other organizations.

MODERN ERA OF CREDIT CARDS

In the 1960s, credit-card organizations began to emerge that issued licensing agreements to other financial intermediaries. The Bank of America, for example, created the BankAmericard and licensed its use to other banks throughout the country. Later to be known as Visa International, the BankAmericard approach was a new dimension in the development of the credit-card industry and became the precursor of companies like Master Card and Discover. The 1970s saw a significant movement toward the internationalization of credit cards, and the 1980s were characterized by the development of ATM machines and other electronic devices designed to facilitate monetary transfers.

The use and effectiveness of credit cards was enhanced in the 1990s by the personal computer revolution--especially the emergence of the Internet. And now well into the 21st Century, the Internet and the emerging cashless society are maturing as major companions of the credit-card industry. Whether used for big-ticket items like computers or smaller items like books and videos, over 90 percent of Internet sales are facilitated by credit-cards (ETI, 2003). At the present time the five leaders in the credit-card industry are Visa International, MasterCard, American Express, Discover, and Diner's Club (ETI, 2003), but many overseas credit-card providers are making inroads in this profitable industry including Euro Card.

EVOLUTION OF THINKING

While the credit-card has evolved institutionally and organizationally, it has also evolved philosophically and strategically. Considered initially as a provider of convenience, it soon evolved as a facilitator of sales revenues with the sales themselves being the means to enhance profits. During this period it was usually expected that the card balances be paid off each month, and to encourage that practice an interest charge was instituted almost as a negative penalty to enforce compliance. But it didn't take long for the companies to discover and appreciate the profitability of the interest charges themselves, and the industry generally shifted from unpaid balances as a negative to a thinking that was at least neutral on balances being carried forward.

From this era of neutrality toward unpaid balances evolved a more aggressive strategy that even encouraged the carry-over of balances, and payments became a main source of income for the credit-card providers. As a further income source, the methods used to calculate the interest charges were "enhanced" and resulted in actual interest charges being greater than advertised or theoretical interest rates. …

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