Unraveling the Mysteries of High Credit Card Interest Rates

A study by NBER delves into the economic intricacies behind the high interest rates charged on credit cards in the United States. While global average interest rates for loans and bonds hover around 4%, credit card interest rates average a staggering 22%. This article unravels these complexities, focusing on lifetime cash flows from approximately 550 million monthly accounts representing nearly the entire US credit card market. Despite the high rates, charge-off rates (around 6%) do not fully explain the significant spread over short-term interest rates. Non-interest income and reward payments help offset non-interest expenses, but key revenue sources include interchange fees and other non-interest income. Operating costs, especially marketing, are substantial and serve to generate pricing power. After accounting for these factors, credit card lending still earns an asset return of 6.8%, nearly four times the average banking sector ROA. This high return is due to a default risk premium estimated at 4.3%, similar to that found in high-yield bonds. Nevertheless, this rate still provides an alpha of around 1.5% relative to the broader bank sector performance. The study offers valuable insights into the lucrative structure of credit card products and their wider economic implications.