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How Competitive Is the Credit Card Market?

T he credit card market is highly competitive, particularly among card issuers but also among payment networks based on several different metrics. Industry competition keeps prices low, promotes innovation, and gives consumers the power to choose the card that works best for them.

In a landmark U.S. Supreme Court case confirming the “two-sided market” as a fundamental framework for analyzing the credit card market, the Court found that the credit card market lacked any hallmarks of a noncompetitive sector. In fact, there are at least four parties involved in most credit card transactions. There are the cardholder, the cardholder’s bank (the “issuing bank”) that extends credit on the card, the merchant, and the merchant’s bank. A credit card network uses its brand to communicate to the customer where their card will be accepted, and various processors can play a role in ensuring data reaches the right place.

The card brands (or “networks”) act as intermediaries, balancing and connecting the needs of everyone in the transaction through established rules, so that transactions happen in a fraction of a second. There are actually two dynamic markets that banks serve (issuers market cards to consumers and commercial cardholders and acquiring banks provide card acceptance services to processors and card-accepting businesses). In the middle are the card brands, working to attract both issuing banks and merchants to their network.

These distinct segments of the value chain provide significant space to innovate and compete. Over the past 10 years, 13 issuers have been in the top 10, 32 issuers have been in the top 20, 80 issuers have been in the top 50, and 163 issuers have been in the top 100. This movement over the last decade, including among the largest issuers, is indicative of a competitive market. New card acceptance solutions like Checkout.com, Toast and Square have created options for retailers, competing aggressively with the traditional merchant processor ecosystem. All of this change has taken place without government intervention, demonstrating that the foundations of the card marketplace foster rather than inhibit innovation and that the marketplace is flexible, rather than protective of incumbents.

A common, generally accepted measure of market concentration is the Herfindahl-Hirschman Market Concentration Index. The U.S. Department of Justice uses the HHI to analyze market concentration when, for example, a merger might affect industry competition. According to DOJ, markets in which the HHI is between 1,500 and 2,500 points are considered “moderately concentrated,” while markets where the HHI is higher than 2,500 points are considered “highly concentrated.”

As shown in Figure 1, neither the credit card issuing industry nor the financial transactions processing, reserve and clearinghouse activities industry—which includes credit cards, financial transaction processing and electronic financial payment and funds transfer services—meet DOJ’s threshold of a concentrated market. Indeed, several other industries that rely heavily on credit cards (for example, department stores, bookstores, wireless carriers and passenger car rental) are significantly more concentrated.

As shown in Figure 2, the top 50 credit card issuers account for nearly all the credit card market in both 2012 and 2017. For a national marketplace where regulations provide guardrails that standardize some (but far from all) product features, this is not surprising. In comparison to domestic commercial airlines, for instance, the card issuance market has many more major players. There are also thousands of card-issuing financial institutions in the US, many more than in similarly-sized foreign countries, and barriers to issuing cards are virtually nil for regulated lenders. Again, card issuance options for consumers compare well to trying to find thousands of airlines selling tickets. Of course these are different products, which is why it makes sense to delve into the particularities of each market (like the card market being a two-sided market) before jumping to any conclusions. The reality that the card market is not actually concentrated is demonstrated by the HHI scores in Figure 1.

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14 comments:

#15BAL120# Credit cards facilitates the buyer(consumer) in purchasing things, even though he/she has no balance in the account up to certain limit. However,this facility may draw him/her to spend in purchasing unnecessary things and makes him/her extravagant. He/she has to pay the debt and recoup his/her account. Isn't it against the saving habits of Indian society and the accepted norms that one should spend according to his needs only?

Credit cards do more harm than good to the consumer as a whole. The credit card industry has caused more people to go into debt than any other industry. They have been the source of more heartache, grief, and deceit than any other industry save perhaps the collection companies. However, credit card companies have their own collections departments so they still fall into that category. the one gets in a habit of purchasing unnecessary

Yes credit card company has power to influence people by the offer that without having money you can buy. It leads to people stop thinking rationally and spend money without caring about their budget.

I agree that Credit card industry largely resembles the perfectly competitive market. India has also entered this almost-perfect market. We have launched our own card scheme called RuPay with the help of National Payments Corporation of India (NPCI).

As we do today discussed in the class that what do we mean my large when it comes to large number of buyers and sellers in a perfect competition. So in my opinion ,large number implies that each firm is very small in comparison to the total market and if one firm has to become significantly large it would dominate the market and competition would be eliminated or at least diminished.

Credit cards market is flourishing one reason is there flexibility in dealing with the worldwide transactions whether you have money in your account or not you can fulfill your desires to a great extent ,but this laxity is also because it is actually helping the credit card firms to prosper with huge usage. Hence we can say both the market and buyers of the desired product compliment each other to let the. Flow of economy to grow.

Credit card market resembles a perfectly competitive market.But question arises whether the banks who are providing these cards also thinks that they are in a perfectly competitive market? Because in these market the advertising of products is just a waste because it will not influence the market instead of it we can see a lot of advertisement and promotions they do to influence the market by influencing the mindset of the buyers,in case of India these promotions obviously works because here more you highlight your product,more the chances of your product will increase .So its true that credit card is a perfectly competitive market but up to what level if not in the world but what in India??

Credit card companies are the example of perfectly competitive market as no single buyer or seller influences the market. There are many sellers and buyers are even greater in number. Because of Advertising, certain company might get an edge over the other co. but it doesn't completely throw out the other co. in the credit industry.Advertising doesnt create a monopolistic situation so credit industries will still be called the perfectly competitive market even if certain co. Are advertising their cards. 15bal105

Credit card companies can easily allure the consumers to purchase unnecessary items. The facility to buy a good without worrying about the cash tends to hamper the prudency of a person. This ultimately results in making a purchase beyond the budget. The credit card scheme has an extremely high tendency to bring down the savings of a person. 15BAL099

as you have mentioned that this is a perfect competition,why cant this be a oligopoly market? 1) as we know that the major market share of the credit card market is shared by few sellers and major thing is 2) the product can be differentiated by the payment gateway they were offered like master card or visa card. 3)considering the natural barrier the company needs to have high capital to enter in to the credit card market.

If you are also one of the customers who are in search for americanexpress.comconfirmcard or American express verify card by an online process, then here is the post of americanexpress .com /confirmcard Americanexpress.com/confirmcard is the official website from American Express for their customers to confirm their credit cards. American Express Confirm Card americanexpress.comconfirmcard

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Credit Card Competition and Naive Hyperbolic Consumers

Published: 14 November 2014
Volume 47 , pages 153–175, ( 2015 )

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Elif Incekara-Hafalir 1

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I explain the credit card market’s observed systematic pricing patterns by examining time-inconsistent consumers. I find that time inconsistency steers the competition from long-term borrowing contingent prices to short-term noncontingent ones. This pattern occurs because the consumer in the contracting period underestimates the future charges, and therefore pays attention only to short-term price elements, such as annual fees. The consumer’s risk of default also plays a role in determining who gets which contract.

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Dynamic Pricing of Credit Cards and the Effects of Regulation

Insurer commitment and dynamic pricing pattern

Consumer Demand for Credit Card Services

Mester ( 1994 ) analyzes the credit card market by using a screening model and shows that interest-rate stickiness may be because of asymmetric information between consumers and banks. Parlour and Rajan ( 2001 ) show that default possibility and multi-contracting may result in positive interest rates and non-competitive profits. Brito and Hartley ( 1995 ) show that transaction costs for other loans can explain high credit card prices. Lastly, Evans and Schmalensee ( 2005 ) point out the default risk for seemingly high interest rates.

Strotz ( 1956 ) defines the time-inconsistent consumer as one who does not obey his optimal plan of the present moment when he reconsiders his plan in future periods.

Ausubel ( 1991 ) and Laibson ( 1997 ) were the first to point out the importance of incorporating consumer time inconsistency in models of this market.

For convenience, I consider the consumer making decisions at different periods as different “selves” of the same consumer.

Ausubel ( 1991 ) finds evidence for noncompetitive profits, but (Evans and Schmalensee 2005 ) criticize this evidence on the basis of not adjusting for the differences in the risk factors. Moreover, credit card companies argue that the interest rates are high because of the high default risks, not because of noncompetitive prices (Rougeau 1996 ).

In Section 5.2 , I also analyze an extension where the consumer has a private type, which determines if he is hyperbolic or exponential.

O’Donoghue and Rabin ( 2001 ) introduce a model to represent a partially naive hyperbolic consumer who is aware of his time inconsistency but underestimates its severity. The partially naive hyperbolic consumer knows that future discounting today is {1, β δ , β δ 2 , β δ 3 ,..}, and incorrectly believes that it will be \( \{1,\beta ^{\prime }\delta ,\beta ^{\prime }\delta ^{2},\beta ^{\prime }\delta ^{3},..\}\) from tomorrow onward with \(\beta <\beta ^{\prime }.\)

I can get the same qualitative results for a subset of partially naive consumers, as demonstrated in Section 5.4 . I do not get the same results with sophisticated hyperbolic consumers, since they correctly calculate their future debt just like time-consistent consumers.

This cost is the cost of bankruptcy proceedings and of receiving unfavorable terms in any contract in the future after declaring bankruptcy. The higher credit quality implies a higher cost of default because the higher credit quality consumers have more to lose in terms of forgone favorable terms in future contracts.

It has been documented that over 70 percent of the credit card issuers’ revenue is from revolvers (Chakravorti 2003 ).

My results do not change as long as the upper bound for the interest rate is finite.

Contrary to the standard subgame perfect equilibrium, a naive hyperbolic consumer has incorrect beliefs about his future decisions. This does not create a problem for the definition of the equilibrium in my case, as there is no strategic game after the contracting period, just a decision-making problem.

See Section A.1 in Appendix.

See Section A.2 in Appendix.

See Section A.3 in Appendix .

Secured credit cards typically require a cash deposit and give the owner a small credit limit. They are intended for users with bad credit or no credit as implied in my model.

When the consumer has both contracts in hand and if he accumulates interest-bearing debt then the consumer pays the company with the higher interest rate within the grace period to minimize the interest payment. Foreseeing this, the companies compete on interest rates resulting in zero-profit equilibrium.

When a consumer starts using a credit card for the first time, there is a grace period of about 21 days, during which time no interest accrues. Therefore, at minimum, during these first 21 days, everyone is a convenience user.

For a time-inconsistent consumer, “no default contraint” is different according to each period’s self, and therefore the analysis is more involved, as shown in Section A.3 in Appendix. Adding incomplete information at the top of it would complicate the analysis prohibitively in the current setting. Therefore, I look at the simplest possible case, allowing to see the mechanism at work.

From Section A.1 in Appendix recall that n 1 ( r ) solves the following maximization problem

and \(\frac {\partial n_{1}}{\partial r}<0\) .

I have a numerical example for each case. These are available on request.

I would like to thank an anonymous referee for raising these points.

It is possible to show that \(\beta _{r=1}^{\ast \ast }(\delta )<\beta _{r}^{\ast \ast }(\delta )<\beta _{r=0}^{\ast \ast }(\delta )=\beta ^{\ast }(\delta )\) for δ > δ ∗ .

Note that G c ( l i , r )= C is closer to the origin for higher values of r .

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Tepper School of Business, Carnegine Mellon University, 5000 Forbes Ave, Pittsburgh, PA, 15213, USA

Elif Incekara-Hafalir

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Correspondence to Elif Incekara-Hafalir .

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I would like to thank the co-editor, an anonymous referee, as well as Kalyan Chatterjee, Edward Green, Susanna Esteban, Isa Hafalir, Jeremy Tobacman, and Neil Wallace for their valuable comments and suggestions.

1.1 A.1 Naive hyperbolic consumer underestimates future consumption

If the consumer is not planning to default, the consumer pays all of his debt back by the last period. Therefore, only the first period borrowing will create interest revenue, but not the second period borrowing. Therefore, I analyze only first-period new borrowing. First, I analyze the exponential consumer as the benchmark (0≤ δ ≤1 and β =1). The exponential consumer is time consistent, and therefore the first-period borrowing according to the contracting-period self ( \({n_{1}^{0}},\) believed amount of borrowing) and according to the period-one self ( \({n_{1}^{1}},\) actual amount of borrowing) is the same ( \({n_{1}^{0}}={n_{1}^{1}}\) ). Exponential consumers can either be borrowers or convenience users, but cannot switch between these roles. There is a δ ∗ such that the contracting-period self correctly knows that he will not pay interest for δ ≥ δ ∗ (convenience user). Therefore, this self is unresponsive to interest rates. Nevertheless, being unresponsive to interest rates does not hurt him because he will not pay interest in the future anyway. The companies earn zero profit even without competition on interest rates. If δ < δ ∗ , then the contracting-period self correctly knows that he will pay interest (borrower). Therefore, this self looks for the lowest interest rate. As a result, a Bertrand competition drives the interest rates down to zero. A naive hyperbolic consumer, on the other hand, has a self-control problem and is not aware of it ( β <1). Consequently, this consumer underestimates his future borrowings \(\left ({n_{1}^{0}}<{n_{1}^{1}}\right )\) . The following proposition shows that there is a naive hyperbolic consumer (specified by δ and β ) who has a contracting-period self that plans to use the card for transactions only, but who has a period-one self that ends up using it for borrowing.

Proposition 5

For a naive hyperbolic consumer, there is a δ ∗ , such that \({n_{1}^{0}}\leq m\) for all δ≥δ ∗ . There is also a \(\beta _{r=1}^{\ast }(\delta )>0,\) such that \({n_{1}^{0}}\leq m<{n_{1}^{1}}\) for all \(\left (\delta ,\beta \right ) \) where δ≥δ ∗ and \(\beta <\beta _{r=1}^{\ast }(\delta )\) .

We start the analysis with an exponential consumer. It is a dominant strategy for the consumer to pay off as much of his borrowing in the grace period as possible. Therefore, if \(~{n_{1}^{t}}\leq m,\) then \({p_{2}^{t}}={n_{1}^{t}}\) and \({p_{3}^{t}}={n_{2}^{t}}\) ; if \(\ {n_{1}^{t}}>m,\) then \({p_{2}^{t}}=m\) and \({p_{3}^{t}}=\left ({n_{1}^{t}}-m\right ) \left (1+r\right ) +{n_{2}^{t}}\) . As a result, the consumer’s utility function is as follows:

If \({n_{1}^{t}}\leq m,\) then \(U_{{n_{1}^{t}}\leq m}=\delta \left [u\left (m+{n_{1}^{t}}\right )+\delta u\left (m-{n_{1}^{t}}+{n_{2}^{t}}\right )+\delta ^{2}u\left (m-{n_{2}^{t}}\right )\right ]\) .

If \({n_{1}^{t}}>m,\) then \(U_{{n_{1}^{t}}>m}=\delta \left [u\left (m+{n_{1}^{t}}\right )+\delta u\left ({n_{2}^{t}}\right )+\delta ^{2}u\left (m-\left ({n_{1}^{t}}-m\right ) \left (1+r\right ) -{n_{2}^{t}}\right )\right ]\) .

The solutions to these two utility functions show that

\(\max U_{{n_{1}^{0}}\leq m}\geq \max U_{{n_{1}^{0}}>m}\) for δ ≥ δ ∗ , irrespective of the interest rate, and

\(\max U_{{n_{1}^{0}}\leq m}\leq \max U_{{n_{1}^{0}}>m}\) for \(\delta <\delta _{r=1}^{\ast }\) .

Completing the proof demonstrates that \(\delta _{r=1}^{\ast }<\delta ^{\ast }\) .

For \(U_{{n_{1}^{0}}\leq m}\) , the consumer’s maximization problem at time zero is given by:

The Lagrangian is given by

The set of FOCs is as follows:

If \({n_{1}^{0}}=m,\) then λ 1 ≥0 and λ 2 =0. If \( {n_{2}^{0}}=0,\) then Eq. 5 creates a contradiction; therefore \({n_{2}^{0}}>0\) and λ 3 =0. Then, by Eqs. 4 and 5 ,

There is a δ ∗ such that Eqs. 6 and 7 both hold for δ ≤ δ ∗ where δ ∗ is determined by \(u^{\prime }(2m)=\delta u^{\prime }\left ({n_{2}^{0}}\right )\) and \(u^{\prime }\left ({n_{2}^{0}}\right )=\delta u^{\prime }\left (m-{n_{2}^{0}}\right )\) . However, Eqs. 6 and 7 cannot simultaneously hold for δ > δ ∗ . Hence, \({n_{1}^{0}}\leq m\) for δ ≥ δ ∗ .

For \(U_{{n_{1}^{0}}>m}\) , the consumer’s maximization problem at time zero is given by:

If \({n_{1}^{0}}=m,\) then λ 1 ≥0 and λ 2 =0. If \( {n_{2}^{0}}=0,\) then Eq. 10 cannot hold; therefore \({n_{2}^{0}}>0\) and λ 3 =0. Then, by Eqs. 9 and 10 :

For a given r , there is a \(\delta _{r}^{\ast }\) such that Eqs. 11 and 12 both hold for \(\delta \geq \delta _{r}^{\ast }\) where \(\delta _{r}^{\ast }\) is determined by \(u^{\prime }(2m)=\delta (1+r)u^{\prime }\left (m-{n_{2}^{0}}\right )\) and \(u^{\prime }\left ({n_{2}^{0}}\right )=\delta u^{\prime }\left (m-{n_{2}^{0}}\right )\) . However, Eqs. 11 and 12 cannot simultaneously hold for \(\delta <\delta _{r}^{\ast }\) . Thus, \({n_{1}^{0}}>m\) for \(\delta <\delta _{r}^{\ast }\) .

Therefore, \(\delta _{r}^{\ast }\) decreases with r and \(\delta _{r=1}^{\ast }<\delta _{r}^{\ast }<\delta _{r=0}^{\ast }=\delta ^{\ast }\) . In summary, the consumer borrows less than or equal to m if δ ≥ δ ∗ and more than m if \(\delta <\delta _{r}^{\ast }\) .

An exponential consumer with δ ≥ δ ∗ correctly believes that he will borrow less than his income. A naive hyperbolic consumer with an exponential discount factor δ ≥ δ ∗ possesses the exact same belief \(\left ({n_{1}^{0}}\leq m\right )\) , but his belief might not be correct, depending on his hyperbolic discount factor. I now analyze the first-period-self of the naive hyperbolic consumer with δ ≥ δ ∗ . As before, the consumer’s utility function is as follows:

If \({n_{1}^{t}}\leq m,\) then \(U_{{n_{1}^{t}}\leq m}=u\left (m+{n_{1}^{t}}\right )+\beta \delta u\left (m-{n_{1}^{t}}+{n_{2}^{t}}\right )+\beta \delta ^{2}u\left (m-{n_{2}^{t}}\right )\) .

If \({n_{1}^{t}}>m,\) then \(U_{{n_{1}^{t}}>m}=u\left (m+{n_{1}^{t}}\right )+\beta \delta u\left ({n_{2}^{t}}\right )+\beta \delta ^{2}u(m-\left ({n_{1}^{t}}-m\right ) \left (1+r\right ) -{n_{2}^{t}})]\) .

I follow similar steps as before and solve these two utility functions separately and show that \(\max U_{{n_{1}^{1}}>m}\geq \max U_{{n_{1}^{1}}\leq m}\) for all \(\left (\delta ,\beta \right ) \) where δ ≥ δ ∗ and \(~\beta <\beta _{r=1}^{\ast \ast }(\delta )\) .

For \(U_{{n_{1}^{1}}\leq m}\) , the consumer’s maximization problem at time one is as follows:

For δ > δ ∗ and β =1, the constraints are not binding, and hence λ 1 , λ 2 , λ 3 =0. Moreover, one can show that \(\frac {\partial {n_{1}^{1}}}{\partial \beta }<0\) and that there is a β ∗ ( δ ) such that the constraint ( \({n_{1}^{1}}\leq m \) ) is binding for β < β ∗ ( δ ).

For \(U_{{n_{1}^{1}}>m}\) , the consumer’s maximization problem at time one is as follows:

For δ > δ ∗ , r =1, and β =1, the constraint \(\left (-{n_{1}^{1}}\leq -m\right )\) is binding, and it can also be shown that \(\frac { \partial {n_{1}^{1}}}{\partial \beta }<0\) . Moreover, there is a \(\beta _{r=1}^{\ast }(\delta )\) such that the constraint \(\left (-{n_{1}^{1}}\leq -m\right )\) is not binding for \(\beta <\beta _{r=1}^{\ast }(\delta )\) . Footnote 23

Thus, I conclude that the contracting-period self believes that he will borrow less than or equal to m in the future consumption periods, but the period-one self ends up borrowing more than m for all ( δ , β ) where δ ≥ δ ∗ and \(\beta <\beta _{r=1}^{\ast }(\delta )\) .

In Fig. 2 , I demonstrate how a naive hyperbolic consumer’s period-one self might end up borrowing more than his income even though his contracting-period self plans not to. The x-axis shows the δ discount factor in [0,1]. The y-axis shows the β hyperbolic discount factor in [0,1]. The contracting-period self believes that the β discount factor does not affect his future consumption plans. If the parameter values that define the consumer are in region A 1 or A 2 , then the consumer believes that he will not accumulate interest-bearing debt. If the parameter values are in region C , the consumer believes that he will accumulate interest-bearing debt and pay interest even if the interest is at the highest possible rate. On the other hand, the period-one self takes β into account when deciding how much to borrow. For the period-one self, the interest rate ( r ) and the exponential discount factor ( δ ) are no longer the only determinants of borrowing; the hyperbolic discount factor ( β ) plays a role as well. Therefore, the vertical line at \(\delta _{r=1}^{\ast }\) separating the interest payers from convenience users at the highest interest rate transforms into the downward sloped line in the diagram. If the consumer is in region A 2 , B 1 , or C , his period-one self accumulates interest-bearing debt even at the highest interest rate. However, there is a conflict between what the contracting-period self believes and what the period-one self ends up doing if the parameter values are in region A 2 , irrespective of the interest rate. Proposition 1 shows the existence of consumers in this region. I analyze only the consumers in region A 2 throughout the paper. Although the contracting-period self is unresponsive to interest rates, the period-one self ends up paying interest.

β and δ cutoffs for a naive hyperbolic consumer’s borrowing

1.2 A.2 Contract choice depending on credit limits

In summary, if the offered credit limits are l 1 and l 2 :

if \(\max \left \{ l_{1},l_{2}\right \} \geq n^{0}>\min \{l_{1},l_{2}\}\) , then the consumer accepts the contract with the higher credit limit only.

If \(\min \left \{ l_{1},l_{2}\right \} \geq n^{0}\) , then the consumer accepts one contract randomly.

If \(\max \left \{ l_{1},l_{2}\right \} <n^{0}\) , then the consumer accepts both contracts.

1.3 A.3 Default consideration according to different period selves

Suppose that l 1 and l 2 are in the appropriate ranges, such that the consumer chooses only one contract. Then, the unselected contract’s interest rate does not affect the gain from default. The gain from default is G 0 (l 1 ,l 2 ) with \(\frac {\partial G_{0}}{\partial l_{1}}=\frac {\partial G_{0}}{\partial l_{2}}>0,\) according to the contracting-period self, and is G c (l 1 ,r 1 ) with \(\frac { \partial G_{c}}{\partial l_{1}}>0\) and \(\frac {\partial G_{c}}{\partial r_{1}} >0,\) according to the consumption-period selves if the selected contract is (l 1 ,r 1 ). Moreover, G 0 (l 1 ,l 2 )<G c (l 1 ,r 1 ) for low enough values of l 2 and for all r 1 ∈[0,1].

In the contracting period, the consumer’s total utility is

if he plans to default, and

if he does not plan to default.

Therefore, the gain from defaulting according to the contracting-period self is given by \(G_{0}=\frac {1}{\beta \delta ^{3}}\left (U_{t=0,~d=-1}-U_{t=0,~d=0}\right ) \) and \(\frac {\partial G_{0}}{\partial l_{1} }=\frac {\partial G_{0}}{\partial l_{2}}>0\) (adjusted according to the last period self).

When the consumer reaches the first period with the chosen contract (which is ( l 1 , r 1 )), he realizes that his actual debt is more than his income. Therefore, the consumer’s total utility is as follows:

Therefore, the gain from defaulting planned in the first period is

\(G_{1}=\frac {1}{\beta \delta ^{2}}\left (U_{t=1,~d=-1}-U_{t=1,~d=0}\right ) \) .

When the consumer reaches the second period, the total utility is

Therefore, the gain from defaulting planned in the second period is \(G_{2}= \frac {1}{\beta \delta }\left (U_{t=2,~d=-1}-U_{t=2,~d=0}\right ) \) . As a result, the gain from defaulting according to the consumption period selves is \(G_{c}=\max \{G_{1}(l_{1},r),G_{2}(l_{1},r)\}\) with \(\frac {\partial G_{c} }{\partial l_{1}}>0\) and \(\frac {\partial G_{c}}{\partial r_{1}}>0\) .

If l 2 =0 and β =1; then U t =0, d =−1 and U t =1, d =−1 are equal, and consequently any difference between G 0 and G 1 is due to the difference between U t =0, d =0 and U t =1, d =0 . From Proposition 1, the profit maximizing n 1 is less than m for δ > δ ∗ . Therefore, U t =0, d =0 is greater than U t =1, d =0 for δ > δ ∗ . Consequently, G 0 < G 1 for β =1. Additionally, \(\frac {\partial G_{1}}{\partial \beta }=-\frac { \left [ u(m+n_{1}^{1\ast })-u(m+n_{1}^{1\ast \ast })\right ] }{\left (\beta \delta \right )^{2}}<0\) such that \(n_{1}^{1\ast }\) and \(n_{1}^{1\ast \ast }\) represent the profit maximizing n 1 in the case of planning and not planning default, respectively. As a result, G 0 ( l 1 , l 2 =0)< G 1 ( l 1 , r 1 )≤ G c ( l 1 , r 1 ) for all r 1 ∈[0,1].

The reasoning behind this lemma is as follows. The contracting-period self believes that he will not pay interest; therefore, the gain from defaulting is not affected by interest rates. Moreover, a marginal gain from each credit limit increase is the same because the credit limits always appear as a sum in the gain function. Consumption-period selves, on the other hand, realize that they pay interest; therefore, the gain from defaulting increases with the interest rate of the chosen contract. The credit limit offered by the contract that is not chosen does not affect the gain because the contracting period has already passed, and the consumer has only the chosen contract on hand. As a result, the set of credit limits that do not induce the consumer to default are shown by the shaded area in Fig. 3 . Footnote 24

The no-default-region if only one contract is chosen

If I further investigate the gain functions from different selves’ point of view, I find that two different effects determine the gain. One is “the credit effect” and the other is “the spending effect”. The credit effect is the effect of the potential credit limit to default at; it may be larger in the contracting period than in the consumption period depending on other companies’ offers. The spending effect is the effect of the expenditure level, and it is larger in the consumption periods since the consumer spends more than what he had planned earlier. Depending on the contract terms, the credit effect might offset the spending effect or vice versa. For example, G c ( l i , r ) is the restrictive constraint for the lower values of l j (the credit effect is smaller). However, if the consumer chooses both contracts, then the credit effect is the same in all periods (the potential credit limit to default at is constant at l 1 + l 2 ), although the spending effect is greater in the consumption periods. Therefore, the gain from defaulting is determined according to the consumption-period selves, namely, G c ( l 1 , l 2 , r ).

Suppose that l 1 and l 2 are in the appropriate ranges such that the consumer chooses both contracts, and suppose that r 1 ≤r 2 . Then, the gain from defaulting is G c (l 1 ,l 2 ,r 1 ), with \(\frac {\partial G_{c}}{\partial l_{1}}, \frac {\partial G_{c}}{\partial l_{2}},\frac {\partial G_{c}}{\partial r_{1}} >0 \) and \(\frac {\partial G_{c}(l_{1},l_{2},r_{1}=0)}{\partial l_{1}}=\frac { \partial G_{e}(l_{1},l_{2},r_{1}=0)}{\partial l_{2}}>0\) .

The gain from defaulting according to the contracting-period self is the same as before, namely, G 0 ( l 1 , l 2 ). But, the gain from defaulting according to the consumption-period selves depends on the credit limit offers of both companies instead of only one, namely, G c ( l 1 , l 2 , r 1 ) if the lower interest rate contract is ( l 1 , r 1 ). The consumer pays the contract with the higher interest rate fully to minimize the cost of borrowing, which eliminates the higher interest rate from the gain function.

By using the same arguments as in the previous proof: \(G_{0}(l_{1},l_{2})<G_{c}(l_{1},l_{2},r_{1}),\frac {\partial G_{c}(l_{1},l_{2},r_{1})}{\partial r_{1}}>0,\) and \(\frac {\partial G_{c}(l_{1},l_{2},r_{1}=0)}{\partial l_{1}}=\frac {\partial G_{c}(l_{1},l_{2},r_{1}=0)}{\partial l_{2}}>0\) . □

When the consumer has two contracts on hand, the no-default-region is determined by G c ( l 1 , l 2 , r 1 =0)≤ C . This is shown in Fig. 4 .

The shaded region is the no-default-region if two contracts are chosen

1.4 A.4 Equilibrium results

Proof (proposition 1).

By referring to Fig. 1 , I will first illustrate the number of contracts that the consumer will choose under different contract offers and determine whether the consumer will pay interest on them. Afterward, I will determine the equilibria. If the offered contracts lie in region one, the consumer chooses only one contract and pays the agreed interest on that contract. If the offered contracts are in region two, the consumer chooses only one contract but does not pay interest, because the chosen contract’s credit limit prevents him from spending more. If the contracts are in region three, the consumer chooses both contracts but does not pay interest (even the total credit limit offered by these contracts does not allow the consumer to accumulate interest-bearing debt). If the contracts are in region four, the consumer chooses both contracts and pays interest on the contract with the lower interest rate (the total credit limit allows the consumer to accumulate interest-bearing debt and the first-period self pays the contract with higher interest rate within the grace period).

Each company offers a monopoly contract ( l ∗ , r ∗ ) if there is no risk of default. But, when there is risk of default, the companies might not be able to offer the credit limits they want without triggering default. For convenience, from this point on, I analyze the problem from the first company’s point of view. The second company’s problem is similar. The default constraints are G c ( l 1 , r 1 )≤ C and G 0 ( l 1 , l 2 )≤ C assuming that only one contract is chosen in equilibrium. Additionally, G 0 ( l 1 , l 2 )≤ G c ( l 1 , r 1 )≤ C for lower values of l 2 . Suppose that \((l_{1}^{\ast \ast },r_{1}^{\ast \ast })\) is the first company’s profit-maximizing contract offer when the other company offers a zero credit limit. Let \(l_{2}^{\prime } \) be the solution to \(G_{0}(l_{1}^{\ast },l_{2})=C\) and \(r_{2}^{\prime }= \underset {G_{c}(l_{2},r_{2})\leq C}{\arg \max }(l_{2}^{\prime }-m)r_{2}\) . Each company’s contract offer is affected by the other company’s offer only if G 0 ( l 1 , l 2 )= C .

Let C ∗ = G c ( l 1 = m , r 1 =0) and C ∗∗ = G c ( l 1 = n 0 , r 1 =0).

Consider the case C > C ∗ ; I now demonstrate that a company offers a large enough credit limit with a positive interest rate when the other company offers a zero credit limit. If C > C ∗ , then G c ( l ∗ , r ∗ )≤ C might or might not be satisfied. If \( G_{c}(l_{1}^{\ast }=l^{\ast },r_{1}^{\ast }=r^{\ast })\leq C,\) then the monopoly contract is feasible. Otherwise, the company offers \(l_{1}^{\ast }>m \) and \(r_{1}^{\ast }>0\) as the profit-maximizing contract with \( G_{c}(l_{1}^{\ast },r_{1}^{\ast })=C\) . The argument is as follows. Suppose that \(l_{1}^{\ast }=m\) and \(r_{1}^{\ast }=0\) . The company can obtain a higher profit by slightly increasing l 1 and r 1 because the constraints C > G c ( l 1 = m , r 1 =0)> G 0 ( l 1 = m , l 2 =0) are not binding for \(l_{1}^{\ast }=m\) and \(r_{1}^{\ast }=0\) . Suppose that \( l_{1}^{\ast }=m\) and \(r_{1}^{\ast }>0\) . The company can increase its profit by slightly decreasing the interest rate and slightly increasing the credit limit. Last, suppose that \(l_{1}^{\ast }>m\) and \(r_{1}^{\ast }=0\) . The company can increase its profit by slightly decreasing the credit limit and slightly increasing the interest rate. I now show the existence of different equilibria depending on where \(G_{0}(l_{1}^{\ast },l_{2})\leq C\) starts to bind.

If \(l_{2}^{\prime }\geq l_{1}^{\ast },\) then \((l_{1}^{\ast \ast },r_{1}^{\ast \ast })\) and \((l_{2}^{\ast }=l_{1}^{\ast \ast },r_{2}^{\ast }=r_{1}^{\ast \ast })\) is the unique symmetric equilibrium in region 1. This is because \(G_{0}(l_{1}^{\ast \ast },l_{2}^{\ast })<C,\) and each company offers the profit-maximizing contract without triggering default.

If \(m<l_{2}^{\prime }<l_{1}^{\ast },\) then \((l_{1}^{\ast \ast },r_{1}^{\ast \ast })\) and \((l_{2}^{\ast },r_{2}^{\ast })\) is an equilibrium such that \(m<l_{2}^{\ast }\leq l_{2}^{\prime }\) and \(r_{2}^{\ast }>0\) . This is because the second company cannot offer more than \(l_{2}^{\prime }\) and does not have an incentive to offer less than m . Moreover, the second company can offer a positive interest rate without triggering default, as \( G_{0}(l_{1}^{\ast \ast },l_{2}^{\ast })\leq C\) and \(G_{c}(l_{2}^{\ast },r_{1}^{\ast })<G_{c}(l_{1}^{\ast \ast },r_{1}^{\ast })\leq C\) .

If \(l_{2}^{\prime }\leq m,\) then \((l_{1}^{\ast \ast },r_{1}^{\ast \ast })\) and \((l_{2}^{\ast },r_{2}^{\ast })\) is an equilibrium such that \( l_{2}^{\ast }\leq l_{2}^{\prime }\) and \(r_{2}^{\ast }\geq 0\) . This is because the second company cannot offer more than m , and consequently makes zero profit.

If C ∗∗ ≤ C ≤ C ∗ . \((l_{1}^{\ast },r_{1}^{\ast })\) and \((l_{2}^{\ast },r_{2}^{\ast })\) are then an equilibrium where \(0\leq l_{1}^{\ast }\leq l_{1}^{\ast \ast },r_{1}^{\ast }\geq 0,\) and \(0\leq l_{2}^{\ast }\leq l_{2}^{\prime },r_{2}^{\ast }\geq 0\) . The companies cannot offer more than m without triggering default, and consequently there is no profitable deviation (region 2 or region 4). Companies make zero profits with or without competition on interest rates. In region 4, the equilibrium contracts are zero-interest contracts, because the consumer accepts two contracts in this region and pays the higher interest rate within the grace period.

If \(C\leq C^{\ast \ast },(l_{1}^{\ast },r_{1}^{\ast })\) and \( (l_{2}^{\ast },r_{2}^{\ast })\) are then an equilibrium where \(l_{1}^{\ast }+l_{2}^{\ast }\leq n^{0},r_{1}^{\ast }\geq 0,\) and \(r_{2}^{\ast }\geq 0\) . There is no profitable deviation, as the total credit limit to be offered to the consumer without triggering default is not more than the consumer’s income (region 3).

Proof (Proposition 2)

The naive hyperbolic consumer’s contracting-period self does not plan to borrow more than his income at any consumption period, but his period-one self ends up borrowing. The exponential consumer, on the other hand, correctly believes that he will not borrow on the credit card. But, in equilibrium, noncompetitive interest rates can be observed depending on the default risk. This follows from the fact that neither the exponential consumer nor the naive consumer’s contracting-period self are responsive to interest rates. Being unresponsive to interest rates neither hurts the exponential consumer nor benefits the companies since the consumer does not borrow anyway and consequently there are no profits from lending. But, when it comes to naive hyperbolic consumers, being unresponsive to interest rates hurts the consumer and benefits the companies as showed in 1. With probability p , the consumer is naive hyperbolic, and the company earns profit with the of probability \(\frac {p}{2}\) by offering a positive interest rate and a high enough credit limit. With probability 1− p , the consumer is exponential, and the company does not earn a profit from him independent of the interest rate. As a result, the companies do not have an incentive to compete on the interest rates. □

Proof (Proposition 3)

If companies offer positive interest rates for one-period-loans, then the company with the higher interest for the one-period loan can profitably deviate by offering a smaller interest for the one-period-loan. Therefore, no equilibrium contract will have a positive one-period-loan interest. The consumer is not responsive to interest rates for two-period loans, the companies can safely offer a monopoly interest rate for two-period loans if the default risk is low enough. □

Proof (Proposition 4)

According to both the contracting-period self and the period-one self, the consumer’s utility when he reaches the period-two is given by

\(u(m-n_{1}+n_{2})+\widehat {\beta }u(m-n_{2})\) if n 1 ≤ m , and

\(u(n_{2})+\widehat {\beta }u(m-(n_{1}-m)r-n_{2})\) if n 1 > m .

I denote the optimal period-two borrowing as \(n_{2}^{\ast }(n_{1}, \widehat {\beta })\) .

According to the period-one self, the consumer’s utility when he reaches this period is:

\(u(m+{n_{1}^{1}})+\beta \left [ u(m-{n_{1}^{1}}+n_{2}^{\ast }({n_{1}^{1}}, \widehat {\beta }))+u(m-n_{2}^{\ast }({n_{1}^{1}},\widehat {\beta }))\right ] \) if \({n_{1}^{1}}\leq m,\) and

\(u(m+{n_{1}^{1}})+\beta \left [ u(n_{2}^{\ast }({n_{1}^{1}},\widehat {\beta } ))+u(m-({n_{1}^{1}}-m)(1+r)-n_{2}^{\ast }({n_{1}^{1}},\widehat {\beta }))\right ] \) if \({n_{1}^{1}}>m\) .

I denote the optimal period-one borrowing according to the period-one self as \(n_{1}^{1\ast }(\beta ,\widehat {\beta })\) .

But, according to the contracting-period self, the consumer’s utility when he reaches the first period is:

\(u(m+{n_{1}^{0}})+\widehat {\beta }\left [ u(m-{n_{1}^{0}}+n_{2}^{\ast }({n_{1}^{0}},\widehat {\beta }))+u(m-n_{2}^{\ast }({n_{1}^{0}},\widehat {\beta })) \right ] \) if \({n_{1}^{0}}>m,\) and

\(u(m+{n_{1}^{0}})+\widehat {\beta }\left [ u(n_{2}^{\ast }({n_{1}^{0}}, \widehat {\beta }))+u(m-({n_{1}^{0}}-m)(1+r)-n_{2}^{\ast }({n_{1}^{0}},\widehat { \beta }))\right ] \) if \({n_{1}^{0}}\leq m\) .

I denote the optimal period-one borrowing according to the contracting-period self as \(n_{1}^{0\ast }(\widehat {\beta })\) .

Let us consider the case when \(\beta =\widehat {\beta }\) (sophisticated hyperbolic consumer). If \(\widehat {\beta }=1,\) then \({n_{1}^{0}}={n_{1}^{1}}=0\) . As \(\widehat {\beta }\) decreases, \({n_{1}^{0}}={n_{1}^{1}}\) increase and there is a cutoff β ∗ such that the \({n_{1}^{0}}={n_{1}^{1}}\leq m\) for \( \widehat {\beta }\geq \beta ^{\ast }\) and \({n_{1}^{0}}={n_{1}^{1}}>m\) for \( \widehat {\beta }<\beta ^{\ast }\) . Now, \(\widehat {\beta }\geq \beta ^{\ast }\) stays the same but β decreases starting from \(\widehat {\beta }\) . Decreasing β does not affect the optimal period-one borrowing according to the contracting-period self, but does increase the optimal period-one borrowing according to the period-one self. As \(\beta \rightarrow 0, {n_{1}^{1}}\rightarrow \infty \) . Therefore, there is a \((\beta _{r=1}^{\ast \ast }(\widehat {\beta }),\beta ^{\ast })\) such that \( {n_{1}^{0}}\leq m\) and \({n_{1}^{1}}>m\) for \(\beta <\beta _{r=1}^{\ast \ast }(\widehat {\beta })\) and \(\widehat {\beta }>\beta ^{\ast }\) . This means that there are partially hyperbolic consumers with a contracting-period self who believes he will not borrow more than his income and with a period-one self who ends up borrowing more than his income even at the highest interest rate of r =1. □

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Incekara-Hafalir, E. Credit Card Competition and Naive Hyperbolic Consumers. J Financ Serv Res 47 , 153–175 (2015). https://doi.org/10.1007/s10693-014-0208-4

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Received : 01 May 2012

Revised : 01 October 2014

Accepted : 08 October 2014

Published : 14 November 2014

Issue Date : April 2015

DOI : https://doi.org/10.1007/s10693-014-0208-4

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Home » Management Case Studies » Case Study of J.P. Morgan Chase : The Credit Card Segment of the Financial Services Industry

Case Study of J.P. Morgan Chase : The Credit Card Segment of the Financial Services Industry

As result of mergers and acquisitions activities Chase Credit Card Services (CCS) became fifth largest credit card issuer in the industry. Being a child of a highly reputable J.P. Morgan Chase bank the CCS has many competencies and competitive advantages in order to compete in already saturated credit card market . Evolvement of internet and technology , globalization , legislation and modernization of financial industry is giving new opportunities for expansion of the credit card business . Despite of intense competition among the banks to acquire and retain profitable customers this market still has a great potential for the right players. CCS reached a critical point when it is equipped with the right instruments and now needs to demonstrate that it is able to leverage them the most optimal way to maximize its profit and prove to its parent investment banking company that it still deserves to be a part of Chase core business.

Strategic Issues

Business and Corporate Credit Cards
Domestic and International Expansion

The trends of consolidation and technological advance in the credit card segment require CCS to decide the geographical scope it should expand the business. J.P. Morgan Chase did not have an international presence of its commercial banking but it did have a strong international presence of its investment banking sector. So CCS could leverage this brand name recognition on other countries to acquire new customers. Although CCS does not have an appropriate infrastructure to service credit card customers abroad it has a capital to acquire international portfolios along with the required technology and infrastructure. The only competitor of CCS in international business is Citibank which has a dominant position. However, the industry is consolidating much faster that Citibank alone can absorb. So if CCS starts competing for international portfolios it can participate with Citibank in absorbing this consolidation.

The consolidation trends are intense in domestic market as well. Many commercial banks exit credit card business and put their portfolios up for sale. CCS has a needed capital to acquire these portfolios as well as a leading infrastructure already in place to service them. Due to tremendous potential of the internet and technology CCS has lots of opportunities for internal growth on domestic markets. Online shopping and other activities require introduction of easy, secured and reliable payment methods and fast access to short-term credit.

Factors contributing to strategic issues

Intense Competition : Credit Card industry is already saturated several years and all players in this industry intensively competing to acquire new profitable customers. The companies explore different ways to do it: co-branded cards, affinity cards, agent banking cards and others. A strong competition is present in all sectors: Individual, Business and Corporate. As result of so intense competition there is a rapid consolidation in this industry. Smaller participants sell their credit cards portfolios to the largest firms and only those who have very strong competencies are able to survive in this business.
Buyers Power : There are three categories of the credit card customers: individuals, businesses and corporate clients. Individual customers is the largest segment of this market but due to lack of brand loyalty, lots of other products and low switching costs it is very hard and expensive to attain these customers. In this situation the customers have a high bargaining power which causes decrease in the profits. The main part of the income from individual and business customers is coming from the interest charged on revolving accounts. So these clients are strongly bargaining on the interest rates. The revenue from corporate clients is coming from fee income and does not depend on interest rates. Corporate clients are more loyal since they have more barriers to switch to other providers.
Substitutes : This is a very big threat. First of all, it is always possible to use cash, paper checks or electronic checks. Also there are debit and smart cards for online and regular transactions. The types of other credit cards are galore on the market. They all offer different features appealing to the clients: low interest rates, affinity with some organizations, rebates on certain purchases, etc.
Suppliers : Since each credit card must be supplied with a lot of capital and this market is still growing and have great potential and underserved areas the suppliers have a high power. They provide a capital, brand name and potential clients from their existing commercial and investment relationships.
Entry Barriers : In light of the situation in this market the only possible way to enter is through M&A. Due to saturation levels this industry is not that attractive for the new players.

(b) Firm’s Relative Strengths

Largest credit card issuer in the domestic market; strong competitor for corporate and co-branded credit cards with established relationships within airlines, gasoline and other industries; Parent company is well known in investment banking domestically and internationally; Has a capital to acquire more credit card portfolios domestically and abroad; Possesses a leading industry platform Paymentech for acquiring and servicing clients; Has chase.com site for serving online customers allowing them to check balance, online statements and pay bills electronically;

Alternatives:

Pros: still has good growth prospects; has a higher entry barrier since acquiring new corporate clients is more based on very strong reputation of the issuer; requires a special technology for servicing; does not depend on interest rates as revenue is coming from fee income; payment on charges is guaranteed by corporations so no loan losses.
Cons: sector is dominated by American Express; more sales efforts should be done to acquire new clients (direct mail, advertisements, etc would not work).

Individual clients segment .

Pros: market is very large; various sources of income (interest charges, late and administrative fees, annual fees); many channels to offer cards (co-branding, affinity and agent banking);
Cons: extremely intense competition; lack of brand loyalty; dependence on interest rates; loss on defaulted loans; low switching costs; many other payment alternatives;

Domestic expansion only .

Pros: many portfolios are up for sale and CCS has a required capital; good technology for acquiring and servicing domestic clients is already in place; strong commercial banking presence would help to acquire loyal customers; the strongest competitor Citibank is more focused on international expansion; most large domestic corporations already have relationship with J.P. Morgan Chase; no need to compete with foreign banks who have good relationships with foreign corporations that could limit CCS abroad.
Cons: Citibank may change its focus from international back to domestic expansion; lack of diversification through international exposure which could protect CCS from declines in US economy
Pros: provides a good international diversification; strong international presence in investment banking sector would facilitate acquiring new customers; CCS able to compete for international individual and corporate clients as well; Only Amex and Citibank have greater name recognition worldwide, but Amex is more focused on charge card market while rapid consolidation allows CCS to participate in consolidation along with Citibank; International presence can be significantly leveraged in the future.
Cons: lack of international commercial banking presence; lack of international infrastructure for servicing; dominant position of Citibank

Recommendations

In light of the situation on credit card market and considering abilities and constraints of CCS I recommend to simultaneously focus on two directions: international expansion and acquiring more corporate clients in both international and domestic markets. It is very important to act fast in these both directions. CCS has just 24 months in order to demonstrate to top management its high profitability and prove their right to exist as a part of the JP Morgan Chase. CCS also has to catch momentum on the market. Due to all these consolidations domestically and internationally, availability of the required capital, strong name recognition of the parent and industry leading technological platform CCS has all it is required to have a great success in all these markets. It needs to pay attention not only on the external activities but also on its internal relations with the top management who may consider selling off CCS. The CCS management has to activate economies of scope leveraging brand name of investment banking parent in obtaining corporate clients domestically and expanding all types of activities internationally. It should create a kind of value chain within the bank which would show to top management that every time investment banking gets a new client the potential revenue for the same client can be significantly increased due to cross-sale of credit card service.

One of the CCS most important goals is to create a one stop shop for financial services by leveraging a whole power of the financial giant which would allow it to become an integrative part of its core business and acquire a great market share of domestic and international credit card markets.

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