Why Do Banks Reward their Customers to Use their Credit Cards? Sumit Agarwal Sujit Chakravorti Anna Lunn Bank of Canada November 18, 2011 These views do not necessarily represent those of the Federal Reserve These views do not necessarily represent those of the Federal Reserve Bank of Chicago or the Federal Reserve System
Outline Motivation Data Empirical Strategy Results
Research Questions Why do banks give cash-back rewards? Do rewards increase cardholder spending? Do rewards increase cardholder debt? Are rewards used to steal customers from other issuers? Does debt increase over all credit cards?
2009 Card Issuer Revenue and Costs Revenues Annual Fees Cash Advance Enhancements Penalty Fees Interest Interchange 3% 3% 1% Expenses Fraud Operations/Marketing Cost of Funds Chargeoffs 1% 18% 8% 29% 59% 11% 67%
Related Literature Behavioral responses and time inconsistency in credit card markets (Ausubel 1991 and Laibson 1997) Increased consumption from increased credit lines or lower interest rates (Gross and Souleles 2002) Rewards and payment py choice (Ching and Hayashi 2010) Banks use rewards to entice consumers to carry more debt and use finance charges to subsidize rewards (Chakravorti and Emmons 2003)
Data From large national US financial institution Monthly data on spending, payment, and balances along with timing of rewards programs from June 2000 to June 2002 Close to 12,000 accounts Quarterly credit bureau data
Data Advantages Large dataset with little measurement error Monthly time series useful to study high frequency Disadvantages M i it f t i dit d t Main unit of account is credit card account Do not observe total spending (cash, check, debit card)
Cash-back Incentive 1% cash back given to certain cardholders in the middle of the sample period 90 percent of cardholders redeem cash back at some point Average redemption is $10 and average total redemption is $25
Table 1 Summary Statistics Mean SD Db Debt on Card d(total lunpaid idbl Balance) 2574 3079 Total Purchase Amount 213 777 Total Payment Amount 292 900 FICO Score 727 52 Total Balance on All Cards 10013 13589 Total Credit Cards 5 4 Income 58249 97040 Age 48 13
Empirical Strategy Compare card spending and change in card debt 1 month before to 3, 6, or 9 months after Y it = f (cash back indicator, time indicator, account controls, demographic controls, portfolio controls) Where Y it is monthly card spending, change in card debt, or change in credit bureau quarterly balance Using OLS estimation with individual fixed effects and clustered standard errors
Selection Issues Some statistical differences exist between treated and untreated groups for some variables but bias is not systematic Bank is unlikely to select certain types of customers for cash-back due to regulatory concerns If targeting occurred, the bank should have targeted more g g, g non-revolvers to increase revenue
Spending, Change in Debt, Change in Overall Balances 75 65.16 (14.26) 57.99 (16.27) 74.81 (14.13) 55 38.34 (26.39) 35 30.28 (27.87) 15 11.59 (31.90) 11.94 (46.71) -5 Spending Debt Change -24.45 (36.99) Total Balance Change -25 3 Months 6 Months 9 Months -16.15 (38.96)
Debt and No-Debt Cardholders (3 Months) 100 80 78.78 (40.77) 60 50.61 (27.65) 56.51 (22.46) 58.23 (64.94) 40 20 0-12.66 (47.41) -9.11 (76.97) Spending Debt Change Total Balance Change -20 No Debt Debt
Transactors and Inactive Cardholders (3 Months) 150 111.87 (23.81) 100 50 20.86 (68.76) 41.41 (49.78) 24.86 (101.51) 0 Spending Debt Change Total Balance aa Change -50-100 -70.87 (49.37) -150-126.49 (124.47) Transactors Inactive
Single vs. Married 100 Spending 90 80 70 Spendin ng/month 60 50 40 single married 30 20 10 0 3 Months 6 Months 9 Months
Gender 100 Spending 90 80 70 ing/month Spendi 60 50 40 male female 30 20 10 0 3 Months 6 Months 9 Months
Income th Sp pending/month Deb bt Change/Mon 90 80 70 60 50 40 30 20 10 0 80 70 60 50 40 30 20 10 0-10 Spending 3 Months 6 Months 9 Months DbtCh Debt Change 3 Months 6 Months 9 Months Less than $40k Greater than $40k Less than $40k Greater than $40k
Credit Limit Spending 160 140 120 100 80 60 40 20 0 200 Spending 3 Months 6 Months 9 Months Debt Change Less Than $6k $6k-12K Greater than $12k 150 Debt Change/Month h 100 50 0 3 Months 6 Months 9 Months Less Than $6k $6k-12K Greater than $12k -50
Card Utilization Debt/Credit Limit Spending 90 80 Spe ending/month 70 60 50 40 30 20 10 0 3 Months 6 Months 9 Months Less than 50% Greater than 50% DbtCh Debt Change 100 80 Debt Change/Month h 60 40 20 0-20 -40 3 Months 6 Months 9 Months Less than 50% Greater than 50% -60-80
APR Reduction Certain individuals are offered interest reductions These reductions average 10% Unlike cash back, APR reductions occur throughout the sample period
Impact of APR Reduction on Spending, Debt and Change in Total Balance 350 329.99 (113.05) 300 250 200 203.34 (57.94) 257.21 (41.96) 3 Month 150 6 Month 100 9 Month 50 0 3 month 6 month 9 month
Conclusion Cash-back rewards increase card spending The overall balance held across all credit cards does not change, which suggests that consumers substitute spending to cards that provide rewards Cash-back rewards are an effective tool for issuers to increase spending on a specific card (top-of-wallet) of APR reductions tend to shift more spending than cash-back rewards