One business that every Indian banker would love to hate is credit card lending.
The Reserve Bank of India’s policy rates are at a historic low and banks are aggressively cutting their rates on mortgages and automobile loans to prop up consumer demand in a sagging economy, but credit card loan rates are rising. This is because defaults on credit card loans have been increasing and no bank is making money on its card business.
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ICICI Bank Ltd, the country’s largest private sector lender, has closed about 1.5 million accounts of credit card customers and brought down the total number to around seven million. Until last year, the bank was acquiring about 200,000 customers every month. Now, the number has come down to about 20,000. ICICI Bank is not the only one which is weeding out unwanted customers. Others in the business such as State Bank of India, HDFC Bank Ltd and Citibank NA have been doing so with the same aggression that they had shown in acquiring new customers until a year ago, when the economy was booming. They expanded their credit card base with offers such as waiver of annual fees to cash in on rising consumer spending in Asia’s third largest economy. Apart from the big four—ICICI Bank, HDFC Bank, Citibank and State Bank—other big credit card issuers such as Hongkong and Shanghai Banking Corp. Ltd and Standard Chartered Bank and new entrants Axis Bank Ltd, Deutsche Bank AG and Barclays Bank Plc. all chased customers, a strategy most regret. The primary reason for this push was that personal consumption through credit cards in India is one of the world’s lowest, at about 1% of total spending, against global average of 8.6%, Asia Pacific’s 6% and China’s 3%.
In the past one year, the outstanding number of credit cards used by Indian consumers has come down from about 27.5 million to 22 million and the pile will shrink further as losses rise with mounting defaults. No bank openly talks about its credit card numbers and figures of non-performing assets, or NPAs, but analysts peg the NPA average in the credit card business at around 10%. India’s third largest credit card issuer, SBI Cards and Payment Services Ltd, a joint venture between the country’s largest lender, State Bank of India, and GE Money, a unit of General Electric Co., had NPAs equivalent to 16% of total credit card lending last year and this figure has not gone down substantially yet. One of the reasons behind the rising default is the high interest rates that banks charge on credit card loans, and one way of tackling this could be paring interest rates. Why can’t the banks bring this down?
I spent an evening with the head of retail banking at a large private bank last week to understand the business. According to this banker, who did not want to be identified, banks have already brought down interest rates on credit-card loans by following a “tier approach”. They have divided credit card customers into different categories, depending on their credit history, and the best lot is charged an interest rate of about 2% per month. Others, depending on their profile, are charged 2.5%, 3% and even 3.5% every month. Those who are prompt in repaying their loans do not necessarily get the lowest rate; the rate of interest is of no significance for them because they do not roll over their credit.
About 60% of Indian credit card customers do not roll over their credit. This means that even if all customers are paying a 3.5% interest rate per month, a bank’s earnings are much less because only 40 out of every 100 customers are rolling over their credit. This is one reason why banks cannot make money on their credit card business. The other deterrent is the small size of credit card transactions. The average transaction size is Rs1,200. Typically, for every transaction, banks earn 1.1% from the merchants—from whom a credit card user buys goods. But the actual earnings for a bank, on every transaction, is much lower, about half a percent, as the customers get free credit for between, say, 20 days and 45 days. Banks have a cost of money, which could be about 60 basis points for a month, if its average cost of deposits is 7% or so. One basis point is one-hundredth of a percentage point. There are other expenses too for running a call centre, sending monthly credit card bills and the cost of the piece of plastic. After taking care of all costs, banks cannot make much money as only 40% of their customers pay interest on rolled-over credit. And this is now being eaten away by rising defaults. Given the low level of spending by customers and the cost structure of the business, no bank can make money from credit card lending in India and, given a choice, they would all like to shut down the business.
Since they cannot do so, they have stopped chasing customers to cut losses. A few banks are revisiting the business model and plan to start charging annual fees, while all are raising the income threshold limit for new customers. They are also cutting down the credit limit for the existing customers. Rising defaults is indeed worrying for banks, but the good news is that despite the aggressive expansion strategy they adopted in the past few years, the overall credit card portfolio for all banks remains very small. So, no bank will go belly up over the increase in card defaults.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as a deputy managing editor of Mint. Comments are welcome at firstname.lastname@example.org