NDP leader Jack Layton arrives at a campaign event in Brantford, Ont., on March 29, 2011. Mr. Layton announced his plan to limit credit card fees for consumers and small businesses.GEOFF ROBINS
NDP leader Jack Layton has introduced a proposal to limit credit card interest rates to a maximum of 5 percentage points over the prime rate.
At the current prime rate of 3 per cent, this would lead to a maximum rate of 8 per cent, this would significantly lower credit card rates, which, according to the Financial Consumer Agency of Canada, on average are 19 per cent for bank-issued cards. Credit cards issued by retail stores are often 29 per cent or higher.
On the surface this would seem to be an excellent way to reduce household debt. If interest payments are reduced, this should leave more money for consumers to pay down their debts and help consumers avoid racking up large debts due to high interest payments.
While the policy appears beneficial at first glance, there are at least three reasons to believe the policy, if enacted, would be counterproductive:
1.It encourages customers to take on more credit-card debt. Interest rates are a price; they are the price of borrowing money. Lower the price and we should expect to see borrowing increase, as we saw in the previous decade with low interest rates encouraging families to take out larger mortgages.
2. Credit card companies have two sources of income from consumers - interest payments and yearly fees. Make interest payments less profitable and we should expect to see credit cards raise their yearly fees. This switch is beneficial to those who keep high credit balances, but is costly to those who pay their balances in full since they are paying higher yearly fees. But paying off credit card debt is exactly the behaviour we would like to encourage.
3. It will reduce access to credit cards for lower income Canadians, either because credit card companies refuse to serve them as it is no longer profitable to do so, or because those consumers cannot afford the higher fees. Some of these consumers will then choose not to borrow, while others will now borrow from payday loan services that charge annual interest rates in the thousands of a per cent. While a 29 per cent yearly interest rate on a credit card is high, it pales in comparison to a 1,290 per cent rate from a payday loan company.
In Economy Lab, Frances Woolley found a more effective way to reduce credit card debt:
"Prof. Stewart's research suggests that there is an easy way to get consumers to pay off credit card debts more quickly. In his experiment, when minimum payment information was removed from credit card statements, the mean amount repaid on credit card bills rose by 70 per cent, from £99 (23 per cent of the balance) to £175 (40 per cent of the balance)."
Removing minimum payment information or alternatively raising the monthly minimum payment level would be a more effective way of reducing the credit card debts of Canadians.
Mike Moffatt is a chemical industry consultant and a Lecturer in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business
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