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Why Are Credit Card Rates Sticky?

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  • Mester, Loretta J

Abstract

This paper investigates credit card rate stickiness using a screening model of consumer credit markets. In recent years, while the cost of funds has fallen, credit card rates have remained stubbornly high, spurring legislators to consider imposing interest rate ceilings on credit card rates. The model incorporates asymmetric information between consumers and banks, regarding consumers' future incomes. The unique equilibrium is one of two types: separating (in which low-risk consumers select a collateralized loan and high-risk consumers select a credit card loan), or pooling (in which both types of consumers choose credit card loans). I show that a change in the banks' cost of funds can have an ambiguous effect on the credit card rate, so that the credit card rate need not fall when the cost of funds does. Usury ceilings on credit card rates are detrimental to consumer welfare, so would be counter to their legislative intent.

Suggested Citation

  • Mester, Loretta J, 1994. "Why Are Credit Card Rates Sticky?," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 4(4), pages 505-530, May.
  • Handle: RePEc:spr:joecth:v:4:y:1994:i:4:p:505-30
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    Cited by:

    1. Shubhasis Dey, 2005. "Lines of Credit and Consumption Smoothing: The Choice between Credit Cards and Home Equity Lines of Credit," Staff Working Papers 05-18, Bank of Canada.
    2. Freixas Xavier & Hurkens Sjaak & Morrison Alan D & Vulkan Nir, 2007. "Interbank Competition with Costly Screening," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 7(1), pages 1-27, May.
    3. Akin, Guzin Gulsun & Aysan, Ahmet Faruk & Kara, Gazi Ishak & Yildiran, Levent, 2008. "Non-price competition in credit card markets through bundling and bank level benefits," MPRA Paper 17768, University Library of Munich, Germany.
    4. Kulasekaran, Sivakumar & Shaffer, Sherrill, 2002. "Cost efficiency among credit card banks," Journal of Economics and Business, Elsevier, pages 595-614.
    5. Omar A. Abdelrahman, 2016. "Credit Card Rates and Consumer Switch: New Evidence," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 8(12), pages 95-105, December.
    6. Park, Sangkyun, 1997. "Effects of price competition in the credit card industry," Economics Letters, Elsevier, vol. 57(1), pages 79-85, November.
    7. Berlin, Mitchell & Mester, Loretta J., 2004. "Credit card rates and consumer search," Review of Financial Economics, Elsevier, pages 179-198.
    8. Akin, Guzin Gulsun & Aysan, Ahmet Faruk & Borici, Denada & Yildiran, Levent, 2013. "Regulate one service, tame the entire market: Credit cards in Turkey," Journal of Banking & Finance, Elsevier, vol. 37(4), pages 1195-1204.
    9. G. Gulsun Akin & Ahmet Faruk Aysan & Denada Boriçi & Levent Yildiran, 2011. "The Role of Simultaneous Regulations of Credit Services and Payment Services on Competition," Working Papers 604, Economic Research Forum, revised 08 Jan 2011.
    10. Shubhasis Dey & Gene Mumy, 2005. "Determinants of Borrowing Limits on Credit Cards," Staff Working Papers 05-7, Bank of Canada.
    11. Kartik B. Athreya, 2004. "Fresh start or head start? Uniform bankruptcy exemptions and welfare," Working Paper 03-03, Federal Reserve Bank of Richmond.
    12. Athreya, Kartik, 2006. "Fresh start or head start? Uniform bankruptcy exemptions and welfare," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2051-2079, November.
    13. Elif Incekara-Hafalir, 2015. "Credit Card Competition and Naive Hyperbolic Consumers," Journal of Financial Services Research, Springer;Western Finance Association, vol. 47(2), pages 153-175, April.
    14. Calem, Paul S. & Gordy, Michael B. & Mester, Loretta J., 2006. "Switching costs and adverse selection in the market for credit cards: New evidence," Journal of Banking & Finance, Elsevier, vol. 30(6), pages 1653-1685, June.
    15. Sougata Kerr & Lucia Dunn & Stephen Cosslett, 2004. "Do Banks Use Private Information from Consumer Accounts? Evidence of Relationship Lending in Credit Card Interest Rate Heterogeneity," Working Papers 04-08, Ohio State University, Department of Economics.
    16. Lown, Cara & Peristiani, Stavros, 1996. "The behavior of consumer loan rates during the 1990 credit slowdown," Journal of Banking & Finance, Elsevier, vol. 20(10), pages 1673-1694, December.
    17. Sherrill Shaffer, 1995. "Rethinking disclosure requirements," Business Review, Federal Reserve Bank of Philadelphia, issue May, pages 15-29.
    18. Posey, Lisa L. & Yavas, Abdullah, 2001. "Adjustable and Fixed Rate Mortgages as a Screening Mechanism for Default Risk," Journal of Urban Economics, Elsevier, vol. 49(1), pages 54-79, January.
    19. Christine A. Parlour & Uday Rajan, 2001. "Competition in Loan Contracts," American Economic Review, American Economic Association, pages 1311-1328.
    20. Ronel Elul, 2005. "Collateral, credit history, and the financial decelerator," Working Papers 05-23, Federal Reserve Bank of Philadelphia, revised 01 Mar 2007.
    21. Ayadi, O. Felix, 1997. "Adverse selection, search costs and sticky credit card rates," Financial Services Review, Elsevier, pages 53-67.

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