The Problem with Banning Floors on Credit Card Rates
On Tuesday, the Federal Reserve issued its final rule governing credit card issuers, all 1,155 pages of it. Reuters’ Felix Salmon has found something worrying in it and it has to do with a rule against putting “floors” on credit card interest rates. Some card issuers set minimum rates, or “floors,” below which a variable rate cannot fall.
For example, if a card issuer offers a variable rate of 17%, which is calculated by adding a margin of 12 percentage points to an index with a current value of 5%. However, the terms of the account provide that the variable rate will not decrease below 17%. As a result, the variable rate can only increase, and the consumer will not benefit if the value of the index falls below 5%. in other words, if you’re paying 12 percentage points above Libor, you pay 12 percentage points above Libor, no matter how low Libor goes.
Now that the Fed has banned such floors, the problem should be solved. Not so, says Salmon. He thinks the problem is due to the fact that interest rates are very low right now. Once the Fed starts raising interest rates, things will change. He gives the following example:
If I want to charge a 9.9% interest rate today, I need to peg the card’s interest rate at Prime + 6.65%, and the rate on the card will start rising as soon as Bernanke raises rates by so much as a quarter-point.
Clearly a Prime + 3.9% card with a floor of 9.9% is a better deal for consumers than a Prime + 6.65% card. But the Fed is banning the former product, and forcing issuers into the latter.
