Designing “Win-Win” Rate Caps

We show how a rate cap can be designed to improve both consumer and lender welfare in the credit card market. We analyze transition paths resulting from different rate caps in a model with revolving credit lines, search frictions, and lender market power. Our analysis shows that if a rate cap only applies to new credit card issuance and not existing accounts, it can improve lender welfare. Incumbent lenders benefit because they can retain their customers for a longer time. New issuers are not affected as long as the posting of credit offers is competitive (zero expected profits in equilibrium). Consumers benefit because of lower interest rates. The rate cap that maximizes consumer welfare leads to gains to consumers and lenders that are equivalent to a onetime transfer worth 0.44 percent of disposable income. The gains to consumers amount to 73 percent of the value of credit access.