Banks Can Be Severely Impacted by a Proposed 10% Cap on Credit Card interest Rates.

President Donald Trump wants to put a 10% interest rate cap on credit cards for a 1-year time period. Doing so could have many potential implications and could severely impact credit card companies’ ability to generate a profit and affect other banking institutions with high exposure to credit card businesses. The implications can and will be significant if this bill passes, it sounds like great savings for consumers but there may be other implications. First it doesn’t look like banks are willing to back down against Trump. If credit card companies are capped at 10% interest rates, approximately 90% of all credit card trade lines would become unprofitable for companies. Most credit card companies and banking institutions stated that if this occurs those lines of credit would simply be closed out and consumer with only the highest credit scores (740+) will still be able to retain use of their cards.

Yield Inversion

A proposed cap on credit card interest rates of 10% would be a net positive for many consumers, however, the issue lies in a generic cap and could have many unforeseen consequences. Although interest rates are project to come down in the coming year, if interest rates increased there is a possibility that mortgages and credit cards could potentially have an inverted yield curve. In this scenario this could be a very negative things for the credit card industry as banks would simply not issue new credit cards due to the opportunity cost of issuing other lending products. Although the expectation is that interest rates may come down in the future that is certainly not guaranteed and if interest rates increased after the cap, the entire economy could get all out of whack.

Revision

Don’t allow credit card interest rates to invert other yields. Credit card debt is unsecured debt and unsecured debt should have a higher interest rate than secured debts. This is just the general way interest rates should function at a macroeconomic level. If this wasn’t the case, consumers would likely take on credit card debt to buy a home instead of taking out a mortgage. Again, the implications could be quite significant and having unsecured credit card interest rates capped at 10% could make for some wonky economics in general. If credit cards become in short supply consumers would just gravitate towards other lending products like personal loans which could be potentially worse off for them.

Credit Card Companies

The announcement caused a large drop in the share price of many banking institutions and credit card companies. A 10% interest rate cap would be detrimental to their bottom line and could vastly change the credit card industry as we know it today. In response to this news many institutions stated they will simply not maintain non-profitable credit card positions for their customer. This would mean that approximately 90% of all issued credit cards would be closed.

Consumers

In theory, a 10% interest rate could be a big money saver for many consumers. Consumers could save billions in interest but a hard cap might not be the best approach even though it would provide a lot of savings. Interest rates are usually tiered and due to this it’s best to have interest rates “prioritized” by securitization or risk, not to just have an arbitrary cap (even though it sounds good on paper). A tiered cap or a reduction in the amount of the spread banks and other lending institutions can charge might be a better approach.

Everyone wants consumers to save money on high interest credit cards, it’s a gripe that has been negatively impacting Americans for years and years. However, this could potentially be a big negative for the banking industry at large (if this idea passes in this bill). It could potentially cause more harm than good if not correctly implemented.