By Tom Rosenkoetter
ABA DataBank
A recent paper from Vanderbilt Policy Accelerator for Political Economy and Regulation prepared by former CFPB official Brian Shearer argues that capping credit card interest rates at 18%, 15%, or even 10% would save consumers tens of billions of dollars a year — without reducing access to credit or cutting rewards. According to the study, banks earn “excess” profits across all risk tiers and could simply trim their marketing budgets to absorb a cap.
It’s a provocative claim, but the study rests on a false premise, flawed methodology and a misunderstanding of how banking works and how firms behave in competitive markets. In reality, the credit card industry is highly competitive, profitability is far lower and more cyclical than the paper incorrectly assumes, and history shows that interest rate caps harm the very consumers they aim to protect by restricting credit access and eroding benefits.
A false premise: a ‘non-competitive’ card market
At the heart of the Vanderbilt study is a paradoxical belief: the credit card industry is both insufficiently competitive and yet spends “too much” on marketing. Those views are hard to reconcile. In genuinely uncompetitive markets, firms typically don’t compete with advertising to win customers. Robust marketing is itself evidence of market competition.
A flawed methodology: How the Vanderbilt study inflates credit card profitability
If the card market is competitive, then what accounts for the study’s finding that profits are excessive and that issuers could simply absorb the impact of a cap without negatively impacting consumers? The answer lies in the Vanderbilt study’s methodology, particularly the period of analysis and the way in which profitability for each risk tier is calculated.
- Flawed definition. The study equates any positive accounting return with economic viability, but lenders must earn enough to cover not just their cost of funds and the cost of providing the service (which includes losses when clients default on their obligations), but also enough to cover their cost of equity and to maintain the regulatory capital they are required to hold against unsecured credit card loans. Once equity requirements and risk premiums are included, the true “hurdle rate” (that is, the rate at which lending in a particular risk tier is profitable) is much higher than the Vanderbilt study assumes, and many of the FICO tiers that appear “profitable” in the Vanderbilt model would not, in fact, be economically viable under a rate cap. Separately, the study calculates return on assets using only outstanding credit card balances. That approach is reasonable for measuring the profitability of the lending function of cards, but it does not properly account for the large population of “transactor” accounts that pay their balances in full each month. These customers aren’t borrowers at all but still generate interchange revenue for the bank. Transactors are a major part of every issuer’s portfolio and are a key market demographic, especially for premium rewards products. The study’s profitability metric effectively excludes these accounts from the industry’s asset base, which mechanically inflates the profitability of high-risk borrowers (who tend to revolve more). This framing overstates the ability of issuers to absorb a rate cap without cutting credit access or benefits for higher-risk borrowers.
- Cycle timing bias. The study examines accounts opened from 2015 to 2017 and tracks them for six years, a period characterized by historically low charge-offs and COVID-era paydowns. However, due to the CARD Act’s restrictions on repricing existing balances, issuers must account for the risk of loss over the account’s lifetime when setting interest rates, including during periods of high financial stress. The study’s conclusions are thus based on a historically calm window of performance, thereby exaggerating “lifetime” profitability (especially for high-risk accounts that tend to see charge-off rates rise during cyclical downturns).
- Misunderstanding of marketing costs. To account for credit card marketing costs, the Vanderbilt study assumes that marketing spend accounts for 20 percent of each card issuer’s operating expenses and allocates these costs equally across risk tiers. That is implausible. A large portion of card marketing consists of television ads for premium travel cards and glossy mailers touting lucrative sign-up bonuses — in other words, campaigns aimed at high-FICO, high-spend customers (not subprime revolvers). By allocating marketing costs equally across risk tiers, the study attributes too much advertising expense to low-FICO tiers and too little to the high-FICO tiers. This misallocation exaggerates the industry’s ability to offset the effect of a rate cap on higher-risk accounts simply by trimming advertising.
As illustrated above, the Vanderbilt study’s ROA estimates for each risk tier are significantly overstated, particularly for accounts with low FICO scores. Indeed, according to the Federal Reserve’s most recent annual Report to Congress on the Profitability of Credit Card Banks, the pretax ROA has averaged 4.2 percent over the last 10 years and was just 3.33 percent in 2023, which is roughly half the ROA used in the Vanderbilt study. After taxes, the credit card industry’s returns are likely closer to 2.5 percent — a profitable business, but a far cry from the study’s conclusion that profits are excessive.
What would actually happen under a rate cap?
Banks and credit unions that issue credit cards are not public utilities. They are businesses in competitive markets. When lending becomes less profitable, the market should expect to see less of it. As such, when the government steps in to restrict the price of credit, the result is that credit availability falls and other fees rise to offset the lost revenue. These changes are typically most acute for those at the margins of the economy — those who, ironically, are the very people the price caps are intended to help.
Previous efforts to impose price caps on lenders bear this out:
- After the 2009 CARD Act limited repricing tools, consumer credit card pricing and availability shifted markedly relative to small business cards, which were not covered by the law. Purchase APRs on consumer cards increased significantly, annual fees became more common and rose in size, credit lines fell and originations tightened, especially for higher-risk borrowers. For additional information about these effects, see ABA’s 2023 letter to the CFPB.
- After debit interchange was capped via the 2010 Durbin Amendment, consumers experienced a sharp decline in the availability of debit card rewards programs and free checking accounts, as well as higher minimum balance requirements and fees. These effects disproportionately affected lower-income consumers, who struggled to meet the more stringent minimum balance requirements and were less able to afford higher fees.
- In Chile, a 2013 rate cap resulted in more than 80 percent of consumers ending up worse off, including 200,000 families that were cut out of the credit market entirely. As typically happens when price caps are instituted, poor and less-educated families bore the brunt of the burden.
These examples show the same pattern: when a major revenue source is constrained, the firm will adjust its credit standards, fees, and product features (including rewards). Contrary to the Vanderbilt study’s assertions, lenders cannot simply absorb the impact of a rate cap. A rate cap will reduce interest revenue, reduce credit access among higher-risk consumers and reduce credit card spending. This will result in lower interchange revenues and fewer cardholder rewards.
The impulse to cap credit card APRs reflects understandable concerns about household debt burdens. Consumers struggling with credit card debt should inquire with their card issuers about debt refinancing opportunities and personalized payment plans. As both economic theory and a century of experience demonstrate, price caps are not the answer. The policy prescriptions recommended by the Vanderbilt paper would make lending to high-risk populations unviable and ultimately cause more harm than good.
Tom Rosenkoetter is executive director of the ABA Card Policy Council.
