The credit card companies are claiming they will have to charge annual fees and cut reward programs for customers who always pay on time because they are being forced to stop ripping off confused customers who incur late fees and sudden doubling of their interest rates.  Ed Yingling, President of the American bankers’ association warns:

“It will be a different business,” said Edward L. Yingling, the chief executive of the American Bankers Association, which has been lobbying Congress for more lenient legislation on behalf of the nation’s biggest banks. “Those that manage their credit well will in some degree subsidize those that have credit problems.”

The idea seems to be that since the price is being cut for the people with credit problem, it will have to be increased for those with good credit.

I claim this is does not make any sense and is not going to happen.  There are two reasons for this.

To understand the first reason, we must consider why credit card companies charge different prices to different consumers in the first place.  This is a form of price discrimination.  To people with lots of outside options, you have to give a good deal – this is the rationale for reward programs for good risks.  For people with few options, you can afford to raise the price – this is the rationale for high interest rates  for the high risk consumers.  To implement price discrimination you have to be able to identify people in the two groups.  The credit card companies have access to both internal and shared data to do this.  You make profits in both markets,  with higher profits presumably in the high risk market if you manage the risk correctly.  If you cannot price-discriminate because you do not have the information or are not allowed to do so by law, you set a uniform price, hiking up the price to the low risk and lowering it for the high risk.  This is the idea Yingling is suggesting.  For a monopolist, uniform pricing makes less profit that price discrimination as it is less targeted to cnsumers’ willingness to pay.

The new legislation is limiting the firms’ ability to impose terms on the high risk consumers.  So, they will make less money in that segment.  But the key point is – legislation is not outlawing their ability to price  discriminate. There is no incentive for them to do uniform pricing as they still have the information, ability and incentive to price discriminate.  As long as the different segments have different patterns of willingness to pay for credit card services, the rationale for price discrimination is present.

Moreover, there is second reason why fees will not go up – competition.  The low risk consumers are profitable as they generate merchant fees because they use their cards frequently.  Suppose all the credit card companies cut rewards and/or impose annual fees.  Then, one company or another has an incentive to cut the fee or increase rewards to steal customers from another.  In fact, this is the most fundamental force keeping fees down and rewards high – the low risk, high volume consumers of credit card services generate revenue.  To entice them to get your card, you have to give them rewards up front.  The legislation does not change this competitive logic.

So, look forward to more points that help keep up the constant upgrading of your iPod.

(Hat tips: Kellogg MBA students – Aneesha Banerjee, Ondrej  Dusek, and Steven Jackson)