Banks Ready to Absorb Defaulting Credit Cards Next

The banking industry

Banks are bracing for their next big hit—defaulting credit cards. The mortgage world has taken its toll on the banks. Bank of America CEO Ken Lewis already warned Congress that despite the billion-dollar bailout, banks will have an “awful year” because of the credit card industry.

Of almost $76 billion in credit card loans, almost $46 billion came from Bank of America, Citigroup and JPMorgan Chase. These large banks have all taken to using questionable tactics to futher mitigate their risk. Some credit cards companies have raised interest rates without notice. Some companies have increased their fees. The companies are using whatever they can to bring in revenue, in hopes of minimizing their loss.

Credit card charge-offs

At the end of last year, bank industry charge-offs, which are loans a bank has rendered uncollectable, reached a historic high of 7.73%. As the unemployment rate increases, analysts project this number to continue to increase along with it. “More people out of jobs, mean more people are going to default on their loans,” states industry analyst Crane Barker. “History has shown us that the charge-off rate typically climbs to 1 point above the unemployment rate…and most people expect the unemployment rate to keep rising throughout 2009.”

History and unemployment

In the 1980s there also was a recession and the jobless rate reached 10.8%. Some people are claiming that the bank got through that recession and banks will get through this one. Unfortunately, no one denies that there are other outside factors that make the jobless rate more detrimental to the economy in 2008, than it was in the 80s. First of all, in the 80s people were not as invested in credit cards or loans as they are now. That day’s lending totals were only a fraction of what they are today. In 1982 there was $70.5 billion in outstanding credit. Today that number is $1 trillion.

How banks will cope

David Robertson, publisher of the Nilson Report, stated that “banks’ credit operations have become much more adept at adjusting to tough economic times after years of practice, including the downturn that followed the dot-com bubble earlier this decade.” Credit card companies are using new and innovative methods of managing the loss. American Express made the decision to pay its cardholders $300 bonuses if they paid off their balance and closed their accounts. Citigroup is working on a joint venture for its credit card division, a division that serves retailers, that would open the door for the company to get out of the credit lending business altogether. Although these banks are shifting their missions with regards to credit, Stuart Gunn, director of Bridge Strategy Group, stated, “If [banks] want to be the retail bank of choice, it means they have to have CDs, debit cards, home equity loans and credit cards. Do you really want to exit one of the major lines of business?”

Banks recovery

Post recession, banks will have to change their ways of lending, but regardless of what happens retail credit cards are a big business. If used properly, credit cards bring in billions of dollars. And the reality is that business and individuals have become dependent on lenders for credit. With the right tools and tweaking, banks can return to the giants they were by still offering credit, but with safeguards built right in.