SRC Insights: First Quarter 2005

The Role of Credit Cards in an Increasingly Indebted World Economy

by Frederick W. Stakelbeck, Jr., Training and Development Coordinator

Long viewed as a mere postscript to mortgages and installment loans when considering the country's overall consumer debt picture, credit cards are now recognized by banking industry experts as key contributors to the epidemic of escalating consumer debt. In its capacity as the nation's payment systems regulator with responsibility for ensuring the safety and soundness of the nation's financial system and for containing systemic risk, the Federal Reserve continues to closely monitor fluctuations in consumer debt levels. Statistics released by the Federal Reserve in February 2004 showed that U.S. household debt, excluding home mortgages but including most short and intermediate credit extended to individuals, reached $2 trillion in November 2003.¹ Of this total, credit card debt represented $744 billion.² One year later, in November 2004, U.S. household debt had grown another 4.8 percent, reaching $2.1 trillion.³

Over the course of the past five years, consumers in Europe and the Far East have joined Americans in embracing the use of electronic payment alternatives such as credit cards to pay for goods and services. Double digit growth in annual credit card receivables in countries such as the United Kingdom, Australia, Taiwan, South Korea, and China have placed pressure on Asian and European consumers unfamiliar with the nuances of managing credit card debt. The growing reliance of American banks and financial services companies on foreign cardholders for sustained income further complicates this situation and merits attention, as credit card issuing giants such as American Express, MBNA, Citigroup, and J.P. Morgan Chase expand their overseas operations.

This article will provide a brief profile of the credit card market for several European and Far East countries. This can then serve as a point of reference for continued research in the area of global credit card debt and related industry trends.

United Kingdom
On July 29, 2004, the Bank of England, the country's central bank, reported that British consumers were nearing the Â£1 trillion mark on credit card, mortgage, and other consumer loan debt for the first time.⁴ Like their United States counterparts, British consumers have benefited from a low interest rate environment. This favorable borrowing environment allowed total credit card lending to grow by 87 percent for the five-year period ending June 2004, compared with a 54 percent increase for all other consumer loans during the same period. However, these favorable borrowing conditions are quickly changing, placing an increased burden upon consumers. Citizens Advice, a British debt counseling service, reported a 44 percent increase over a six year period in the number of Britons seeking debt counseling—an almost identical correlation with the increase in credit card lending over the same period.⁵ The United Kingdom's Treasury Select Committee recently began to study this upward trend in consumer debt. The committee commenced its investigation of the credit card industry, calling on a number of British banks to explain more concisely the exact manner in which credit card charges are presented to consumers.

A new concern for a number of economists is the growth of the nonprime credit card market in the United Kingdom. In a November 2004 report, PricewaterhouseCoopers stated that the nonprime market, which includes nearly 8 million British adults, will be one of the key sources of growth in the United Kingdom credit card market."⁶ The report also noted that the number of credit cards is expected to increase by 3 to 4 million, or 10 percent, over the next several years. Industry penetration will increase to 73 percent of the UK population, compared to 85 percent in the United States. Certainly, developments in UK consumer debt and emerging market dynamics deserve further study.

Australia
Figures released by the Reserve Bank of Australia in December 2004 show that credit and charge card debt reached a record high of A$28.2 billion in October 2004.⁷ Supporting these figures were poll results released by the Sydney Sun-Herald in August 2004 showing an increasing reliance on credit cards by Australians. The poll showed that 68 percent of Australians polled were "revolvers," rolling over their monthly credit card debt and paying only the minimum payment on credit cards that sometimes charged 15 to 20 percent. The poll also noted that 20 percent of Australians found their credit card debt difficult to manage. Statistics released by the Reserve Bank of Australia show the average debt among the 70 percent of households with a credit card reached A$5,162 in 2004, up from A$1,601 in 1996.⁸

With consumer credit card debt soaring, members of Australia's Labor Party have proposed several measures to address the problem. Options discussed include the following:⁹

Allowing a credit card issuer to increase credit limits only if requested by the cardholder.
Prohibiting unsolicited promotional material with pre- approved credit limits.
Requiring financial "health warnings" to ensure that consumers are made aware of the potential cost of credit card finance.
Ensuring monthly statements contain warnings about the timeframe required to repay debt if only the minimum payments are made, as well as the total amount of interest that would be paid.

Taiwan
The credit card market in Taiwan has expanded rapidly during the past five years, with the total number of credit cards in circulation as of December 2003 increasing to almost 40 million, or five credit cards per household.¹⁰ Directly related to the increase in credit card circulation has been escalating consumer debt. As of December 2003, total Visa credit card outstanding balances alone stood at NT$376.7 billion, 28 percent over 2002 levels and 41 percent over 2001 levels, even when adjusted for inflation.¹¹ NT$376.7 billion in total outstanding balances translates into an average balance of NT$17,900 per credit card.¹² Furthermore, according to the Taiwanese Financial Supervisory Commission, the island's population of 48 million residents has approximately US$13.2 billion dollars in cumulative credit card debt.¹³

The Asia Times reported on August 18, 2004 that Taiwan is facing rising credit card and cash card debt and a possible default fiasco similar to South Korea's.¹⁴ How did Taiwan consumers get into so much credit card debt? Taiwanese banks, eager to expand into the credit card market, turned a blind eye toward risk controls and gambled that bad loans would be manageable. It didn't happen, and large commercial banks such as Chinatrust FHC, Fubon FHC, and Taishin Financial Holdings Co. saw charge-off rates soar. At Taishin, chargeoffs reached 6.7 percent as recently as July 2004. Recognizing the immediate danger of these developments to the country's budding economy, Taiwan's Finance Ministry reacted by implementing measures to restrict future credit card growth. In March 2004, the Taiwanese government announced plans to curb delinquencies on household debt by rescheduling payments for nearly 400,000 Taiwanese consumers.¹⁵

South Korea
South Korean household debt has skyrocketed over the past six years. Largely debt-free as recently as 1997, South Korean households now are an average of US$27,000 in debt. A government-fostered stimulus program instituted in 1999, designed to change the historically conservative spending habits of Koreans, has been blamed as the major contributor to the country's current financial condition. Under the plan, any South Korean citizen who spent 10 percent of their annual income on credit cards was given a 20 percent tax deduction. As a result, credit cards, which were hardly in use before 2000, became the payment method of choice for many Korean households. As of December 2003, the average South Korean consumer had four credit cards. Total debt on these credit cards totaled a mind-boggling US$97 billion,¹⁶ an alarming 14 percent of GDP in 2003.¹⁷

Nearly 4 million South Korean households have forfeited on credit card and other loans—an astounding 10 percent of the country's total population. Adding to the country's default woes is an industry-driven lender policy that does not allow revolving accounts.

Bad credit card accounts, an unheard of phenomenon only five years ago, mounted so quickly that South Korea's largest card issuer, LG Card Co., was forced to suspend its cash advance ATM services because it ran out of money. On December 31, 2004, LG Card Co. announced that it had reached an agreement with LG Group, its previous owner, on a bailout package worth US$966 million, easing fears of a company collapse.¹⁸ "We are glad to say we will be able to give a New Year's gift to the financial markets," said Yoo Ji-Chang, governor of Korea Development Bank, LG Card's main creditor.¹⁹

Consumer credit card delinquencies have soared, due in large part to ineffective bank credit risk management policies and internal controls. In their desire to gain a significant foothold in a potentially lucrative market and secure a cadre of loyal credit card customers, banks ignored applicant credit histories and approved almost all credit card applications. This lack of bank oversight in both the credit review and application processes facilitated the development of structural inadequacies within the country's financial system and contributed greatly to the 1997-1998 Korean financial crisis and the 2003 credit card crisis. The existence of these unsound lending practices was confirmed in early 2004 when the Korean Board of Audit and Inspection reported that irregularities in the credit card industry allowed 1.8 million individuals with negligible credit histories to obtain 4.3 million credit cards.²⁰

As a result, credit card issuers are now faced with finding a more favorable balance between price and risk. Credit card issuers have taken deliberate steps to rectify problems associated with the credit card market, reducing cash advance limits, revising credit approval processes, and modifying risk management practices. The Bank of Korea, the country's central bank, has also taken measures to control consumer credit growth. The central bank plans to establish a new "Paper Company" to handle bad debts and charge card delinquencies, although this concept has been questioned by some industry analysts.

No one knows for sure when the country's credit card market will recover entirely from its early mistakes. However, most industry experts agree that the business model employed by South Korean banks, coupled with unwise, ill-timed government intervention, did incalculable, long-term damage to the country's credit card industry.

China
A majority of Chinese consumers still use cash for all transactions; however, major changes are on the horizon. China, with the largest potential credit card market in the world, presents an attractive opportunity for credit card issuers determined to gain as many of the country's billion-plus consumers as possible before competition increases, customer's attitudes mature, and regulation from the China Banking Regulatory Commission (CBRC) intensifies. Issuers such as American Express, Citigroup, Standard Chartered and American International Group (AIG) are preparing to target the Chinese credit card market, using partnerships to work with local banks until restrictions on international lenders are lifted in 2006. "As soon as China opens up, we want to go in," said AIG vice-president Edmund Tse.²¹

"Both domestic and foreign banks have been eyeing with great interest the credit card market in China for years—and for good reason," said Glen Murphy, Managing Director of ACNielsen China, a marketing information company.²² Credit card penetration in provincial areas and cities such as Beijing, Shanghai, and Guangzhou has increased from 18 percent in 2003 to 22 percent in 2004.²³ A recent survey of Chinese consumers between the ages of 25 and 34 found 35 percent hold one or more credit cards.²⁴ According to MasterCard, China could see the number of credit cards in circulation rise from approximately 3 million today to as many as 75 million by 2010.²⁵

Given China's desire for the rapid transformation of its economy from a state-run communist economy to a more diverse, westernized economy; a rise in urban income levels, which have led to increased consumer spending; and the entry of foreign banks into the domestic Chinese market, it may be only a matter of time before Chinese consumers of all ages succumb to the allure of credit cards. To avoid familiar problems associated with market expansion and risk containment in a maturing market, it will be important for Chinese banks to prevent unnecessary risks by educating young consumers on the intricacies of credit. Chinese banks entering this new market will also need to establish the reliable propriety and shared network capabilities that are the pillars of sound controls.

Conclusion
Escalating consumer credit card debt will ultimately have a profound impact on a developing world economy. Increasing consumer debt levels, coupled with any deterioration in the world economy due to unforeseen economic, political, or national security events, could portend a crisis for the global credit card industry. These developments deserve U.S. attention as American credit card issuers increase their presence overseas and explore new markets for growth opportunities.

¹ Federal Reserve System, Statistical Release for Consumer Credit , February 6, 2004.
² Ibid.
³ Federal Reserve System, Statistical Release for Consumer Credit , February 7, 2005.
4 BBC News, UK Debt Likely to Top £1 Trillion, July 29, 2004.
⁵ Ibid.
⁶ Michel Hennigan, Ireland Business News Service, "UK Credit Card Issuers Lose 1 Billion Pounds Annually on Balance Transfers", November 1, 2004.
⁷ The Australian, Credit Card Debt at New High , December 16, 2004.
⁸ Greg Ansley, The New Zealand Herald, "Australian Debt Soars with Property Boom and Easy Credit", August 16, 2004.
⁹ Senator Kate Lundy’s Office, We Owe Almost $28 Billion on Our Credit Cards , November 18, 2004.
¹⁰ Visa, The Credit Card Report: Credit Card Use in Taiwan, September 2004.
¹¹ Ibid.
¹² Ibid.
¹³ Ibid.
¹⁴Scott Ridley, Asia Times, "Taiwan Tackles High Credit Card Default Rate", August 18, 2004.
¹⁵ Ibid.
¹⁶ Shanghai Star, South Korea’s Love Affair With Plastic on the Rocks , May 29, 2003.
¹⁷ InfoShop, Financial Cards in South Korea, July 2004.
¹⁸ Asia News, Creditors Agree to Bail Out South Korean Credit Card Company LG Card , December 31, 2004.
¹⁹ Ibid.
²⁰ David Scofield, Asia Times Online, "Behind the Crisis in South Korea’s Economy ,” July 20, 2004, www.atimes.com/atimes/Korea/FG20Dg04.html.
²¹China Daily, AIG Eyes Credit Card Market in China, January 8, 2004.
²² ACNielsen, From Cash to Credit: China Offers Cash Cow Opportunities for Banks, August 12, 2004.
²³ People’s Daily OnLine, China Steps into Credit Card Era, August 9, 2004.
²⁴ Ibid.
²⁵ Samuel Shen, International Herald Tribune, "Citigroup Adds China Card Market", December 24, 2004.

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.

SRC Insights: First Quarter 2005

The Role of Credit Cards in an Increasingly Indebted World Economy

In This Issue

Contact Us