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In Control with Natasha Vernier
The In Control podcast explores the finance of everything, through conversations with people who’ve done it, built it, or experienced it firsthand. Join host Natasha Vernier as she sits down with leaders, innovators, and experts across the financial industry to explore how it all really works. The focus is on learning aloud and making complex topics accessible.
In Control with Natasha Vernier
Understanding Credit Cards with Susan Ehrlich
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Do you know who Frank McNamara is?
Well done if you knew that he invented the credit card!
On this week’s episode of In Control, I was lucky enough to speak to Susan Ehrlich, and to learn all about credit cards.
Susan ran the credit card divisions at Citibank, Washington Mutual, Sears, and Amazon, including building the Amazon Prime 5% cashback card. Now she's a partner at Core Innovation Capital. In other words: she knows how this industry actually works!
I absolutely LOVED this conversation because Susan was able to go so deep. She taught me about the history of the industry, how banks and merchants make money from credit cards, and completely demystified the proposed 10% cap on interest rates.
You do not want to miss this episode!
We covered:
→ The three revenue streams: interchange fees, interest income, and late fees
→ Why credit cards are the most profitable product banks have
→ How Delta makes $7 billion/year from their loyalty program
→ The origins of the first credit card - The Diners Club - in 1950, started by someone who forgot his wallet at lunch
→ What happens to access and rewards if the rate cap goes through
I'm sure the folks at Chase and the folks at Amazon today will have all kinds of things to say about this conversation, but yet Hello and welcome to Incontrolled, where we learn about the finance of everything.
SPEAKER_01I'm Tash, your host, and I'm also the CEO and founder of Cable, which supports the show. When I lived in England, I would pay for almost everything on my debit card. Meals out, a new pair of shoes, a ticket for a show, all on my debit card. The only things that made it onto my credit card were really, really big expenses. And when I first moved to the US a couple of years ago, I was amazed at how everyone puts everything on credit cards. The average American has more than 6K in credit card debt, and the average Gen Zier, those between, you know, 18 to 28-ish, they have more than three grand of credit card debt. Now that I've lived here a while, and my primary card is, of course, my credit card, I'm definitely interested in optimizing my points. How can I get those free flights? Is cashback better than airline miles? And I honestly can't work out if this is just really good marketing or if there are actually advantages to using credit cards, despite the risks of high interest fees and growing debt. And so I want to understand credit cards from all angles, from the bank point of view as well as the consumer point of view. And I want to understand what the implications are of President Trump's proposed 10% annual cap on credit card interest rates. To do that, I am speaking to a true credit card expert. Susan Ehrlich has run credit card divisions for Citibank, Washington Mutual, Sears, and Amazon. She was president of financial services at Sears and HR Block, CFO at Simple Finance, and CEO at Student Lending FinTech Earnest. She has served on the boards of Arrived Homes, BECU, the third largest credit union in the US, the Financial Health Network, Petal Card, and FinWise Bank. Susan is now a partner at Core Innovation Capital. Wow. What experience. Susan, thank you for chatting with me today. And I guess the question that we start with has to be: what is your primary credit card?
SPEAKER_00Tasha, thanks for having me. I carry, I have to say, I am not the optimizer that you are with credit card. I have been in this industry for you know it for about half the length that cards have been around in the United States. So it's been a while. And I will admit uh that my my two main cards are my BECU uh credit union credit card and my Amazon 5% card, which is a product that I worked on and launched uh when I was at Amazon, what, over 10 years ago? Oh, that's fascinating. So that's a cashback card, right? It is. It's 5% back. I don't know why anybody would shop on Amazon and not use the Amazon Prime card. It is by far the only way to shop at all those uh Amazon outlets and businesses.
SPEAKER_01Okay, we are definitely going to get to credit card points and cashback because like that's a whole thing I want to understand. Um but let's let's really build this up for our listeners. I want to understand the finance of credit cards. Let's start with the finance of credit cards from the bank's point of view. Please just explain to me how do credit cards make banks money? What are the costs involved? Let's really get down to like the basic fundamentals of credit cards from the bank side.
SPEAKER_00Yeah, I think it's fascinating. If uh credit cards, you know, they really haven't been around that long. Like I was saying, uh really, it's been about 75 years that cards, uh the way they currently work, have really been in existence. We can kind of talk a little bit about that history. Um, they are by far the most popular bank product uh in the United States, um, for sure. And they also happen to be one of the more profitable ones for banks, which I think is important, right? So, you know, you know the experience of using your card, right? You're gonna go into a merchant, um, you're gonna try to make a purchase, uh, you're gonna present them with your card, they're gonna swipe it in some way, shape, or form. Uh, that's gonna send a message about that transaction to the merchant's bank who's gonna forward it along to a payment network, a Visa or MasterCard, who's gonna pass it along to your issuing bank. Uh, and they're gonna check and see are you a card member in good standing and do you have enough credit line for the purchase, right? So if if all of those things check out, that's gonna be an approval. You're gonna get your items bagged up and you're gonna be on your way. And you're essentially it's an IOU uh to that merchant that you're gonna pay. And your bank, your issuing bank, kind of settles that uh transaction with the merchant. Um, they get paid the next day, and that item goes on your statement, and at some point you get your credit card statement with the due date, and you decide if you're gonna pay that transaction in full, or you're gonna use some time to make that purchase and uh and uh pay it off over time. So, what's happening on the back end um as the bank that has issued you your card is looking at that. So that bank is is making money on your um card relationship in kind of three major ways. Um the first is interchange, what they call interchange income, swipe fees that are associated with just that purchase transaction itself. Um if you don't pay in full, the bank is gonna earn interest income, your APR, times you know, whatever portion of purchases you didn't pay in full, so your balance. Um and then there's gonna be maybe some other fees in there. Um maybe there's an annual fee on your card because it's a really uh valuable rewards program, or you know, maybe you aren't always paying on time and you've incurred a late fee here or there, or something else. So I'd say there's kind of three major revenue, you know, revenue lines there, revenue components.
SPEAKER_01If we if we just pause on the on those, the first one, the interchange. How is interchange different between credit cards and debit cards?
SPEAKER_00Yeah, so um those there was a point in time where they weren't. Um and the merchants in the United States um filed a lawsuit uh against the payment networks, um, which resulted in something known as the Walmart settlement. Um, because there was a moment in time where the payment networks sort of considered them uh of equal value, they would say, to uh to a merchant. Um but merchants looked at it and said, but they really don't represent equal risk. And so we don't want these things tied together. We want to have interchange rates that really are related to the to the dynamics of those businesses themselves. There's no credit risk really in debit transactions, so why would we be paying the same fees? So they've that you know that sort of disconnected in in kind of the late 90s, early 2000s, I think was that settlement. And so you wind up with these two different structures um on interchange. And interchange for credit card transactions has just typically been higher. Um, interchange pays for the rewards that are in reward card programs. And so over time, as as reward card uh features have gotten richer and richer, you've seen kind of an increase uh of what merchants are assessed in terms of um interchange fees to help banks pay for that.
SPEAKER_01Interesting. So the interchange fees, they're higher than the debit card interchange fees because the merchants are carrying this risk of this is credit. There is some risk that we don't settle this money, we don't get this money back. Um, who sets those interchange fees? Is it MasterCard and Visa?
SPEAKER_00Uh it is, you know, that's been an ever-changing situation too, right? So it is MasterCard and Visa. Um, you know, those those MasterCard and Visa used to be owned by the banks, right? Those used to be cooperatives. And then following the MasterCard settlement, where there was these huge liabilities associated with that settlement. Um, Visa and Master Group, the banks wanted to sort of separate themselves a little bit, kind of shield themselves a little bit from some of the liability of those interchange uh lawsuits. Uh, and so Visa and MasterCard became independent companies, and they are responsible for managing uh those interchange fee schedules, which are incredibly complicated and incredibly complex uh and not very transparent, I would say. So, but that is the subject of a of another podcast entirely. Um I worked uh very I've worked on all sides of the credit card industry uh model. So I've worked on the issuing bank side, where I've been the net beneficiary of interchange revenues, and I've worked on the merchant card acceptance side at Sears and at Amazon, where I've been the party that's being charged those interchange fees, which are very difficult to control that expense from a merchant's standpoint.
SPEAKER_01Mm-hmm. Okay, that sounds like a whole other podcast that I need to do. So if anyone, anyone is a uh an expert on interchange and MasterCard and Visa, let me know. We should definitely have that conversation. Um so the interchange fees being set by MasterCard and Visa, those pay for the rewards. They're higher than debit cards, and they can vary by different types of merchants, and presumably they just go up over time because life. Um okay, so that's the first one. Then you've got the interest income. Um explain for me how APR works.
SPEAKER_00Yeah, well, the uh annual percentage rate is is what is charged on your balances when you're not when you don't make a payment and that and that balance revolves, as they call it. Um and so when you think about that that rate on your card, like that's the rate you would pay on on whatever balances uh you don't repay in a time period. When banks think about it, they think about that rate multiplied by something called the revolve rate, like what percentage of the customers uh uh are going to pay in full, and what percent are going to carry a balance month over month. So they they take that interest rate, the APR, they multiply it by a revolve rate, and that kind of gives them the interest income percentage. So what banks are earning is something, you know, on average across their whole portfolio of customers, is something less than what that APR uh is. It's you know, APRs are running kind of 21 to 23% these days, and and banks are earning 16 to 18% is kind of the number that shows up in their profit and loss statement.
SPEAKER_01Okay. And then you've got that third bucket, which is like some credit cards come with an annual fee, late fees, that kind of stuff. Of those three um income streams for credit card providers, which how where how are they split? Is it you know 50% interchange? Like what is the breakdown uh generally of a split between these through three income streams?
SPEAKER_00Yeah, it kind of depends on how their customers use the card and where they've focused their business. You know, when it's a a rewards card program or a high featured rewards card, they're gonna attract more of what you'd call um transactors, right? People who are charging a lot on their card, paying it off in full, sometimes making payments before the bill is even due to free up credit line and make even more purchases. So that kind of a customer, it's gonna be heavily weighted to interchange revenue and they're really not carrying a balance. You know, whereas there's the flip side, you know, customers that maybe are uh a little bit um uh lower on the sort of prime to subprime um range that are more likely to use the card as a financing vehicle and and not be able to pay in full month over month, really want to take advantage of that uh revolving line feature. Um, then banks that focus on that segment of customers are gonna earn more revenue from interest income than they will from interchange because those that credit line will be full, right? There won't be enough, there won't be a lot of extra credit line available to make purchases to earn interchange. So most of the income will come from the interest income. But I would say uh the preponderance, you know, the the vast majority of revenue is is earned on that interest income in general. Okay.
SPEAKER_01That's super interesting and certainly explains, you know, the targeting different demographics with these credit cards. Something that's always um kind of baffled me is those zero interest promotions. Move your debt to this credit card and you'll have zero interest for a year and there's no fees to set it up. Is the play there purely CAC? This is just a cheap way to acquire customers, and then the hope is that they forget and we get to charge them fees, or they continue to use our card. Is that the purpose of those zero interest promotional offers?
SPEAKER_00Yeah, I mean, I think uh, and you see them less and less, right? The laws and rules around these kinds of programs have changed over time to make it less attractive to banks to do that. Um, you know, typically when they were offered originally, if it was in if if it was in connection to a to a merchant, like we offered 0% uh on Sears cards uh back in the day, and other merchants do that same. You see them from Best Buy and Home Depot. And when those programs were first launched, they were true zero, right? They were really no interest, um, and they were really used as financing promotions to help sell televisions and washing machines and refrigerators. Um, as the banks adopted it, it it was more to what you describe, um a promotional offer uh to make it attractive for you, help you save money in the short term, and you know, kind of operating on the expectation that most people wouldn't be able to pay off the balances fully in the time where the promotion ran, and then those balances would reprice, and and the bank would be able to earn, you know, earn back some of that uh promotional money over time.
SPEAKER_01Yeah. Okay. So that makes a lot of sense. We've got the three core revenue streams there for a bank with a credit card. What are the costs involved for a bank?
SPEAKER_00The costs? Yeah, so they those really fall into kind of um four buckets. Like the first is uh a cost of funds, right? The fact that the the your issuing bank paid the merchant for your transaction the day you walked out of the store, um, you know, and then you know they're collecting transactions and they're not billing you for some period of time that can be up to 30 days, and then your bill isn't due for another 21 to 28 days. And so they have that cost associated with uh with you know with that trend with their financing you, uh, but their cost of funding is pretty low. They're a bank, they've got asset access to the Federal Reserve, and so you know that's their first expense, cost of funds. Um the second is the fact that you know some of the customers they've lent money to um to use their credit card aren't going to pay them back. Uh so that'll be what they would call charge-offs. Um, you know, there's some of those transactions may not have been legitimate charges. Um you didn't authorize that transaction or somebody got access to your card, and you know, there may be some fraud charges, uh fraud losses that they'll incur. Um they'll have reward expenses, right? All those reward, if you know, if it's a reward card and you know they're giving you miles or cash back, you know, they'll have reward uh costs associated with the with the card. And then they just have like operating expenses, right? They've got you know, they're marketing for new customers, they're issuing statements, they're processing payments, they're you know, handling customer service inquiries either online or on the phone. And so, you know, that those kind of make up the four components of costs that that banks have.
SPEAKER_01And this space is super, super competitive right there. Like that you can get a credit card from most banks, most credit unions, a lot of merchants, all these companies now. And those costs feel pretty substantial. Like the operating costs of a credit card, just knowing how much it costs to run a bank without a credit card, those are those are probably pretty high. But you said um right at the top that credit cards are one of the most profitable products that banks have. So that's really interesting. Despite all of this fairly large cost base, they're still very, very profitable for the banks.
SPEAKER_00Yeah, banks think about it as a return on assets, right? This is, you know, as they deploy, you know, their own funding, what kind of a return are they generating on it? And so, you know, the the credit cards are are, you know, I'll say not a very old category, as we said, it's only been around for about 75 years, by far the most popular, right? Eight and ten Americans carry a card. And by far and away, one of the most profitable lines of business for a bank. So banks are earning somewhere between two and four percent as a return on assets, which may not sound really high, but you know, we are running three and a half trillion dollars through our credit cards on an annual basis, you know, and balances outstanding are approaching, you know, uh uh uh you know, well well, you know, billions of dollars in in balances outstanding. So, you know, two to four percent on a very, very, very large number uh turns out to be a lot of money for banks.
SPEAKER_01Yeah. And what that two to four percent return on assets, what that means, let me know if this is this is right or wrong, is a bank that has, I don't know, five billion dollars in assets, which means that's the deposits that they've gathered from their customers that they're keeping in the bank, they are making two to four percent of that total asset, um, asset base in revenue through this credit card and the lending and all those other those other revenue streams they're making.
SPEAKER_00Yeah, they think of I would think about it as you know, whatever proportion of those deposits, right, they have deployed in in making loans and credit card, right? So it's the balance is outstanding, is the assets. So those revolving balances form that that baseline of assets, and this is the return associated with those dollars. And two of them, you know, they're they could be making mortgages, they could be uh making auto loans, they could be doing personal loans. You know, there there are other product categories that they may be involved in, you know, uh lending to consumers. But when you rank stack all of those, um the returns associated with credit cards come out on top of all those options. They'd rather put an extra dollar of um funding available into credit card businesses if they can.
SPEAKER_01Yeah. And I think that you just clarified that I was incorrect. So if a bank has$5 billion in assets, which is all of the deposits they hold, it's not two to four percent on the five billion because they won't be lending out all of that. It's the amount that they're lending out that they make the money. Got it. Okay, that's super helpful. Thank you. Um, so um that is really clear. We've got the the revenue streams for them, we've got the costs involved. That is really easy to sort of understand for banks. What about for merchants? These co-branded credit cards. You mentioned Home Depot, um, Walmart has a credit card. How do those work? At what point does it make sense for a merchant, a brand to have a credit card?
SPEAKER_00Yeah, I think well, merchants would benefit at the you know, uh at the smallest amount of sales uh to have a card program of their own, to be able to offer a way a convenience for a customer to be able to make a purchase, you know, particularly if it's a larger sized transaction, as I mentioned, like a, you know, you're replacing a refrigerator or buying a mattress. Um and it really just is a question of the scale, the economics of scale, uh, whether or not a bank is going to be interested in creating a program uh for a retail partner. And I think technology is going a long way, and you see a lot of fintech companies that are helping reduce the scale required. Um, but I would say back in the day when I was working on these programs, most banks would say if you don't have a million customers, we really can't build a business that would be big enough to make it worth our while. And I think you know, fintech has taken the scale down significantly. But, you know, uh you you really um for it to be worth a bank's trouble to to personalize and customize um their systems and a program, they need to know that this could be a material contributor to their to their business.
SPEAKER_01That makes sense. And that's why there are those credit cards that are like, these are the 15 merchants that if you spend that, so that's sort of aggregating to make it enough customers to make it worthwhile for the bank.
SPEAKER_00Yeah, and I think it's uh, you know, when when banks look to partner with a retailer, they're really looking for how do I get reach? How am I reaching more customers than I would see otherwise? How many people are shopping at this merchant? So, how many chances am I going to have to get in front of that customer while they're shopping or while they're at the point of sale at the at the cash register or the checkout, um, you know, to be able to sh show off my product, um, get them to apply, get them into the program. And so you really they want to see scale. They want to see a lot of eyeballs. They want to see a lot of customers walking through the door to make a program worthwhile from their perspective.
SPEAKER_01Yeah. Okay. That makes sense. And then from the merchant side, are the advantages there of having a credit card? Presumably they get a cut of the interchange. So it's like they get a little bit of revenue that way. Is that right?
SPEAKER_00Yeah. I think um when I how I was thinking about it, you know, when I when I worked and uh and ran these programs, there's kind of a couple of dynamics that that make it interesting. One is just, as I said, like it financing is important. You know, I worked at Sears. Sears Sears doesn't really exist anymore. It had one of the very first credit card programs in the United States, goes back to the 1940s when cards first came on the scene. They launched the Discover card. So Discover Card was an outgrowth of Sears's business. And while the retail side of Sears may not have worked really well, what Sears was really great at was financing and building financing portfolios, both for their own card program, you know, and for Discover. And what they saw is you know a lot of consumers even today would have a difficult time making a$400 purchase. And so if your you know washing machine broke or your refrigerator was on the fritz and you had to come in and replace that, you're going to have a difficult time being able to fork over the cash to do that. So either you know being able to offer a storecard or a co-branded card that enabled a customer to make that purchase today, that was a real convenience and it helped increase sales for the merchant and that was important. It also then now creates a loyalty vehicle right so I can be able you know I've got a means for you know giving special offers to my best customers and again trying to motivate more of their purchases coming to me as the you know as the you know as the merchant. And so I think those are places where retailers see the bulk of the benefit associated with the program is just incremental sales activity and they'd be able to complete a sale that they wouldn't have been able to otherwise. And yes in return for that working with their bank on a co-brand program they usually you know interchange on those transactions usually waived and then they do get you know they they're incented on a per account opened basis so that they've got some skin in the game to be marketing the card program to customers. And sometimes they'll get a a percentage of the profitability of the program overall.
SPEAKER_01Okay. That sounds yeah super beneficial for the merchants then that makes a lot of sense. So from their side any merchant would want to do it and from the bank side they're looking for the merchants with enough eyeballs enough enough coverage so that it actually makes sense for them to stand it up.
SPEAKER_00Yeah and when they you know and the profitability of the program right so the the more that customer base is going to look you know higher quality from a risk standpoint. You know so you think about the airlines programs that are business travelers or you look at you know the home improvement outlets where it's people making an investment in improving a home they own all of these things are kind of risk measures that tell you that the people shopping in these locations are lower risk, lower risk of credit losses associated with higher profitability for the bank.
SPEAKER_01Yeah. Okay. And so we've done the we've done the banks, we've done the merchants what about from the consumer side? Points aside, which we're going to talk about, what are the benefits of using credit cards?
SPEAKER_00Is it just access to money that you might otherwise not have had at that time yeah I mean I think the biggest uh opportunity is convenience right so it's it's the streamlining and simplifying what a what a what what your shopping experience looks like when you're going online or or going into a store. So I think convenience is is the overwhelming benefit. I think flexibility on how and when you're repaying is also useful. I mean that's a even if you're paying in full I mean if you're paying in full that's a free loan right and if you're paying over time that's a convenience of not having to find all of those dollars and and budget them to that first purchase uh you know you can kind of pay it off over time. You know and then you've got the the benefit of whatever loyalty or or re rewards program is kind of attached to the card.
SPEAKER_01Yeah. And I guess like on the on the pessimists side like the other angle of this how big of a problem is credit card debt? Like is this just a a way for banks to make more money and consumers are just getting in more and more debt and that's just the way it is like how big of a problem is the debt?
SPEAKER_00Yeah so when I started working in credit card which was a long time ago Tasha um I I looked at it as a program that was really doing a a good um in the economy. At that time you know we were back in the days where we were just moving to using credit scores and scorecards for kind of approving credit. And so before then you dealt with a banker who used a lot of judgmental underwriting and to be honest people like you and me would not necessarily always qualify for credit from banks. And so the introduction the advent of credit card really democratized access to borrowing from banks. And you know so folks that had been excluded from the financial system in the United States really had access for the first time. And I think working in credit card in those early days you could feel very good about hearing from people that they had qualified for their first credit card or you know they were they finally had a card in wallet and they would proudly show off whatever it was. And I think you know that was different right now we're at the point where as I said like 80% of Americans carry a credit card and many of them have more than one. So now you're you're you one could argue that we might be at capacity right where we've expanded um usage you know we're kind of reaching the limits of of where we are and and maybe in some cases with some consumers we've pushed past that and we're encouraging spend and usage of credit card where it may be you know not an overall social good. But I'm I'm you know personally for the experience that I had in the space proud of the work that we did in terms of um making sure that people were mainstreamed into the financial system in the United States. And is it perfect? Absolutely not is it better than the alternatives that were available at the time and I think even still I would argue um credit cards in general uh do more good than harm.
SPEAKER_01Yeah and and how how does that compare I guess what the do the newer lending methods like buy now pay later do to that model?
SPEAKER_00Is that when you said you know perhaps we've gone beyond that for some consumers is that you talking about newer lending methods like buy now pay later or how do you think about those I think it's more in the cases of the consumers who charge off right if you uh you know I've worked quite a bit in that subprime space and I've worked quite a bit on the collection side of credit card. And I've been at the Financial Health Network and and you know I'm sure you've had other guests on your podcast who quote the Federal Reserve you know most Americans can't come up with$400 to fund an emergency without having to go to friends or family to borrow or find some way to borrow. So a lot of consumers are paycheck to paycheck um which makes any disruption in their financial life difficult. And one of the things that's going to tip is going to be their ability to keep current on their credit card payments and falling too far behind has disastrous consequences on their credit. And so you know when you when you have populations of consumers that are really kind of on that margin um this this product you know can be uh a source for bad as well as for good. And I think those are those are kind of difficult situations to kind of judge um but you know it it's it's not a perfect product that's for sure.
SPEAKER_01Yeah. Okay. Okay. I think we really understand how all of this works from a finance perspective. So let's talk about the thing that I am still trying to wrap my head around which is how credit card points work. So let let's start with like from the from the bank and the merchant angle um explain how the the rewards work who gets paid like points versus cash back. Explain all of this to me.
SPEAKER_00Yeah so um I think I think points predate cash back in the launch of credit cards. So I think the very first airline miles card was American Airlines Citibank and that product uh launched in 1981. Oh wow so that was the very first um rewards program I guess you'd say rewards card and then um Discover card launched you know actually you and I are talking on February 6th the Super Bowl is two days away and Discover card launched with Super Bowl 20 so 40 years. Yep back in yeah 1986 uh and that was the introduction of cash back as a value proposition or rewards product. Yeah so in a um and and that American Airlines rewards program has been very very important to the airline industry in general over the years. So um in the case of a of a points program um you know the bank's earning that interchange from the merchant swipe fee and um they are partnering with an airline most likely uh or a hotel business or some other travel firm um are are usually the biggest points programs and um you know when miles are earned uh those banks are remitting dollars to the airlines and the hotel companies to pay for those points um I think uh when last I looked I think airlines make something like$25 billion a year on airline miles um sales off of these loyalty programs um I think Delta has the biggest program uh right now it's like seven billion dollars of revenue a year like 20% of all the revenue that they make is associated with pay with being paid for miles earned on rewards programs primarily their credit card program. Same is true for United same is true for American Airlines so um you know there's a there's points in time where these loyalty programs really prop up the airline industry uh they're they're high margin because there's really no cost yet associated with them. They're they're like getting prepaid for flights that you may or may not take. And so it's a really great line of business for them.
SPEAKER_01Yeah I did I interviewed Will Messina from Grailpay about payment networks and we were talking about the the Delta um example and how much revenue they make from it. And I I guess I hadn't clicked until now that during COVID that was probably like their only revenue, right?
SPEAKER_00A lifeline. And it's been a lifeline for them at at many times in those business cycles, right? Where the certainty and durability of those dollars coming in that come from loyalty programs has really sustained them.
SPEAKER_01Interesting. Okay so the the bank behind the credit card, they are making their interchange fees and they think that a way to attract more consumers to use their credit card, therefore they can make more money is by partnering with an airline, partnering with United and so they say hey United do you want to launch this credit card with us? We'll pay you to give our customers points for their spending and that's kind of how it goes. Is that it?
SPEAKER_00Yeah I mean I would look at these programs not dissimilar from retail card program right um American Airlines you know looking to to generate more business or more preference for their airline over United and Delta launches a card program to give their customers and people who fly with them a benefit that others don't have or don't receive. And so it's as important and as lucrative as we talked about for that bank for that merchant partner, that airline partner as it is for the bank. And so you know I don't know who led the conversation when City and American Airlines first sat down together, but it's been in extremely lucrative, extremely profitable for both of them you know over the course of time and that that that program.
SPEAKER_01Yeah. Okay. And so then cashback was just presumably a let's be a bit different instead of doing points, I'm a merchant, I'll give you cash back. So it was just another way to use that interchange revenue to attract customers.
SPEAKER_00And this one was launched by a retailer. So if you think about it being Sears that launched the Discover card network, right? This was you know what uh you know uh what value proposition do they have? Well it's turning that interchange um revenue that that is part of a of a network's um revenue earnings right into a reason to give preference uh for spend at merchants where you're going to get that cash back. And you know banks kind of like it better because they're really keeping they really don't owe an airline or a partner any money out of the program, right? They're sitting on all of that accumulated interchange and waiting for you to you know claim your gift card or redeem it for merchandise or request it as a statement credit or pull it out in terms of cash. So they get to to sit on that money and earn whatever additional interest or benefit from perhaps breakage if you don't come back and and redeem your account closes or it goes inactive and you forget you have it like that's found money for them.
SPEAKER_01And so the in the example of the Amazon 5% cashback card it's Amazon paying the cash um the 5% cash back it's not the bank.
SPEAKER_00So it is the bank.
SPEAKER_01So in the case of the 5% program uh it is the bank partner who uh is is uh is funding it um they're not well uh without going into a lot of the specifics on that program it's it's being funded by interchange revenue being earned on that card off amazon uh as well as just the profitability that the bank partner is earning on the program in general interesting it had been the case that that that amazon was paying an interchange fee on their credit card program and so when that card first launched those dollars just got recycled into paying for part of that program um but obviously uh amazon wasn't uh charged five percent so it was closer to two percent yeah there's marketing fees that these programs uh marketing funds sorry that these programs have so you know that was applied toward paying for the five percent and then just over time uh negotiating leverage between the two partners has put more and more of that liability on the banks versus the I bet interesting so as the the merchant becomes bigger and obviously Amazon being just a huge huge merchant so many small transactions as well which goes to those interchange fees um Amazon has the power to try to negotiate that actually they are paying less of that 5%. They're bringing so many customers to the bank they are enabling the bank to make so much revenue from the interchange the interest income those fees that actually they're able to say hey bank you got to fund more of this because we are bringing you so many customers and that's just the power of the merchant in that in that situation.
SPEAKER_00Yes. And I'm sure uh the folks at Chase and the folks at Amazon today will have all kinds of things to say about this conversation. But yeah I would agree with you. It started as a shared expense between the bank and the merchant and then as the program gets bigger and you know depends who has the negotiating leverage at the time, right? That's that gets pushed around between them. But it's my understanding at this point in time um Chase is paying the overwhelming majority of the costs of that reward program.
SPEAKER_01Fascinating and so stepping back and like you know you said that you mostly use your Amazon cashback card and your um BCU credit card with your credit union is it your kind of view obviously no financial advice to anyone listening that like actually points versus cashback it's pretty much the same like just basically whatever you fancy more of if you fly a lot go for miles. If you don't fly a lot cash back do you see any benefit for a consumer to choose one over the other? I am the worst person. You're gonna have to get the points guy on the question. Maybe you can introduce me to a points guy or that and I can dig into that with them. Okay.
SPEAKER_00For sure I mean for me personally like I see the 5% off I shop on Amazon for nearly everything. Yeah so earning 5% back and it's so easy to just apply those points to pay for a transaction in the checkout flow on Amazon uh that to me that's just a no-brainer um if you're not carrying and using the Amazon card particularly for your Amazon purchases like that's just you've you're leaving money on the table that they would gladly give you um if you applied for that card. Yeah. And with BECU that was cash back. So if I wasn't using my Amazon card then to get 2% cash back for using BECU and support my credit union, I'm happy to do that. So I am not a rewards optimizer so I have no tips or tricks facts that you can apply to figure out where you can earn the most money unfortunately.
SPEAKER_01Got it. Okay that makes sense. I want to finish our conversation by trying to understand um Trump's proposed 10% annual cap on credit card interest rates. Because like as a as a simple statement consumers you know hear that and they think well that's great. But there's been a lot of chatter on my LinkedIn feed about actually why this might be detrimental. So explain this to me try to help me understand both sides of this this proposal.
SPEAKER_00Yeah you know um without making any judgments on Trump as a politician or a president you have to give him credit for being a person who knows how to own and control the news cycle. And in this case, you know I I think he has dominated the news in this area. I think it was interesting to note too I'm a subscriber to This Week in FinTech. I'm guessing you probably are as well and they just publish their newsletter for the day and the headline is credit cards are booming and no one cares about the rate cap. And I think that that uh sums up in a nutshell my thoughts on this as well. You have to kind of start with what Trump said. And so I think the the message has gotten garbled in the game of you know telephone or translation that has occurred. So you know Trump was at Davos um he made a statement uh that he called for banks to impose a 10% cap on credit cards for one year. So I think the time limited nature of that is important to understand. It also wasn't an executive order it was just an announcement so it doesn't carry any weight or authority um certainly less weight and authority over something like an executive order. And he set a deadline January twenty sixth 2026 and that day came and went did anyone comply? Uh there no banks complied And as a result, he made an announcement suggesting that Congress should pass legislation to impose this rate cap. And as we all know, Congress is a dysfunctional mess. And so to push it, to kick the can to Congress is to, you know, potentially put this thing on the scrap heap of history. And so you have to ask, well, well, what was he doing? Like why did he do this? And I think there the speculation is interesting. And I don't, I don't know the answer. I wasn't involved in it. But, you know, you could certainly say, hey, did this go into the conversation as a, you know, a comment on affordability and a statement that Trump could make to show that he was on the side of average everyday consumers and trying to fight the good fight on affordability and get a sound bite out there that he can return to for sure. It it ticks the box there for sure. I think it's it's interesting as well. Uh, you know, Alex Johnson, Jason Mikhaul has also have also commented that, you know, Trump and the administration were negotiating with the banks over the Clarity Act and crypto legislation at the time that Trump made this announcement. So was this him creating a bargaining chip to say, hey, I see that very profitable line of business you have over there? And if you want to keep it that way, you know, I need you to give me something over here. Um, and so did it play into you know a negotiation that was happening at the time? I I think that seems very credible, very plausible reason. Um, you know, but in in terms of like, you know, if we took it at face value, like what would actually happen, you know, if banks were required to impose a 10% cap. Um, you know, I think I think there uh, you know, we have a colleague in the industry, Sean Buddy from uh Ensemblix, who's commented on this. He's like, you know, uh price constraints don't eliminate risk, they just reallocate it. So for sure, I think what what banks would most likely do is do everything they could to preserve the profitability of their programs. So, you know, they're gonna um open fewer accounts, right? They're gonna be more attuned to who the profitable low-risk customers are, where they could still make money if they can, uh, with only being able to charge 10%. Um, they're gonna certainly strip away rewards and try to eliminate. That's a very controllable cost for them. So reward program benefits, I think, get reduced pretty significantly. Um, and you know, anybody who's kind of at the the lower end of the FICO range, uh, you know, a near prime or a subprime customer is certainly not gonna get approved for credit. Um, you know, the risk of charge-offs are just too high in those customers with those customers to expect that they're gonna continue to see a card. So, you know, if their card comes up for expiration, it might not renew. Um, if they try to apply for a new card, they might not get one. So I think you'd see credit card revert to where it was when the cards first launched. And it would be, you know, a very low-risk, high transaction, upper income consumer that would still have a card. And most people would be pushed to look at a personal loan or buy now, pay later as an option for making purchases.
SPEAKER_01That's super interesting. So if it had, if it was ever forced, if this was a thing that was mandated for banks, it whilst sounding like a a great soundbite for affordability, actually has the exact opposite effect, probably long term.
SPEAKER_00Yeah, I think for for certainly for a huge swath of people who are currently using cards today, they'd expect to see that that product go away over time. They would they would see annual fees reimposed on them. Um, you know, banks are gonna make them move them move the revenue stream elsewhere, basically. 100%. 100%. Like it's you know, banks aren't gonna, you know, uh there's there's a lot of you know if you if you think about like where the current that where we talked about that current um interest income is at 16 to 18 percent. So you know, card rates are at 21 to 23 percent. You cut that in half, uh, you know, knock that down by that many basis points, like banks aren't just gonna take that, right? They're gonna make it back someplace else. And so consumers will pay for it somewhere, either in not having access to the product or um having the cost of that product be covered some other way. Got it.
SPEAKER_01All right. Um, what have I not asked you about credit cards that you think is like fundamental to how they work?
SPEAKER_00Uh fundamental to how they work? Well, I I think the history is really interesting. So I would recommend if you are at all intrigued in this topic, there's a great book called A Piece of the Action by Joseph Nocera, who really walks through in a really easy to understand way kind of the history of Card and where it began and kind of what it has evolved to today, which I think is great. So I don't know if you know that the very first credit card uh was launched in 1950. Um, and it was the result of a businessman in Chicago going to a business lunch and forgetting his wallet and having the brilliant idea that wouldn't it be great if I could create a network of restaurants that would be willing to accept my card as a means for paying for my meals, and they could just bill me at the end of the month and I could settle. And so the first ever credit card program was the Diners Club launched in Chicago in 1950. So from those very humble beginnings and from that very simple problem that he ran into, uh, an entire industry and category that now generates three and a half trillion dollars of spend, which is more money than the GDP of the UK, uh, the GDP of South Korea was born. Uh and I think that is just a remarkable, remarkable trajectory for a business. Do you know what his name was?
SPEAKER_01Frank McNamara. Frank McNamara started the credit cards. Awesome. Um, Susan, this has been so fascinating. I definitely feel like I understand so much more about credit cards. Thank you so much for teaching me all about it.
SPEAKER_00Thank you for having me on the show and giving me the opportunity to share what I know.
SPEAKER_01And if you're listening and you enjoyed this, please do share uh in control with your friends and colleagues. And don't forget to subscribe on Apple Podcasts or Spotify. And we'll see you next week for another episode of In Control.