A Credit Card Conundrum

Historically, credit-card issuers have been notoriously slow to slash the interest rates they charge consumers. Each week, it seems, a mailing arrives from an aggressive entrant in the credit-card business offering a rock-bottom "teaser" rate. Other competitors offer rebates on such items as cars or plane tickets. Still, it's relatively rare for credit-card companies anxious to build market share to simply lower their rates--as hungry players in other industries do.

It may well be that the economics of price-cutting backfire in the credit-card business. Companies chasing new customers with low rates simply lose profits, according to Loretta J. Mester and Paul S. Calem, economists at the Federal Reserve Bank of Philadelphia. Using the Federal Reserve's rich database on consumer finances, Mester and Calem show that the customers most likely to shift because of a rate cut are the riskier ones. They're looking to escape their crushing debt load built up on the high interest rates charged on their current accounts.

By contrast, a card issuer's most profitable customers--people with high balances and good credit ratings--are unlikely to change issuers because of low rates. These desirable customers are loath to lose the high credit limits they've built up with their current issuer.

Before it's here, it's on the Bloomberg Terminal.