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Why Do Banks Reward their Customers to Use their Credit Cards?
S i A lS i A lSumit AgarwalSumit AgarwalSujit ChakravortiSujit Chakravorti
Anna LunnAnna Lunn
Bank of CanadaBank of CanadaNovember 18 2011November 18 2011November 18, 2011November 18, 2011
These views do not necessarily represent those of the Federal ReserveThese views do not necessarily represent those of the Federal Reserve Bank of Chicago or the Federal Reserve System
Outline
Motivation
Data
Empirical Strategy
ResultsResults
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 Costs2009 Card Issuer Revenue and Costs
3% 3% 1%
RevenuesAnnual Fees Cash Advance Enhancements
Penalty Fees Interest Interchange1%
ExpensesFraud Operations/Marketing Cost of Funds Chargeoffs
1%
8%18%29%
59%
67%
11%59%
Related Literature
Behavioral responses and time inconsistency in credit card markets (Ausubel 1991 and Laibson 1997)markets (Ausubel 1991 and Laibson 1997)
Increased consumption from increased credit lines or lower interest rates (Gross and Souleles 2002)
Rewards and payment choice (Ching and Hayashi 2010)p y ( g y )
Banks use rewards to entice consumers to carry more debt and use finance charges to subsidize rewards (Chakravorti anduse 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 20022002
Close to 12,000 accounts
Quarterly credit bureau data
Data
Advantages
Large dataset with little measurement errorMonthly time series useful to study high frequency
Disadvantages
M i it f t i dit d tMain unit of account is credit card accountDo not observe total spending (cash, check, debit card)
Cash-back Incentive
1% cash back given to certain cardholders in the middle of1% cash back given to certain cardholders in the middle of the sample period
90 percent of cardholders redeem cash back at some point90 percent of cardholders redeem cash back at some point
Average redemption is $10 and average total redemption is $25$25
Table 1 – Summary Statistics
Mean SD
D b C d (T l U id B l ) 2574 3079Debt on Card (Total Unpaid 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 4Total 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
Yit = f (cash back indicator, time indicator, account controls, demographic controls, portfolio controls)g p p )
Where Yit 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 y ypcash-back due to regulatory concerns
If targeting occurred, the bank should have targeted more g g , gnon-revolvers to increase revenue
Spending, Change in Debt, Change in Overall Balancess
75
65.16(14.26)
74.81(14.13)
55
57.99(16.27)
( )
38.34
35 30.28(27.87)
38.34(26.39)
1511.59
(31.90)
11.94(46.71)
-24.45( )
-5
(36.99)
Total Balance ChangeSpending Debt Change
-253 Months 6 Months 9 Months
-16.15(38.96)
Debt and No-Debt Cardholders(3 Months)( )
100
78.78
60
80
50.61(27.65)
56.51(22.46)
(40.77)
58.23(64.94)
40
( 65)
0
20
-12.66(47.41)
-9.11(76.97)
-20
Spending Debt Change Total Balance Change
No Debt Debt
Transactors and Inactive Cardholders(3 Months)
150111.87(23 8 )
50
100
(23.81)
20.8641.41
(49 78) 24.86
0
50
Spending Debt Change Total Balance Change
(68.76)(49.78)
(101.51)
100
-50
Spe d g ebt C a ge ota a a ce C a ge
-70.87(49.37)
-150
-100
Transactors Inactive
( )
-126.49(124.47)
Transactors Inactive
Single vs. Married
100
Spending
80
90
50
60
70
ng/
Mon
th
single
30
40Spen
din
married
0
10
20
0
3 Months 6 Months 9 Months
Gender
100
Spending
70
80
90
50
60
70
ing/
Mon
th
male
30
40Spen
di
female
10
20
0
3 Months 6 Months 9 Months
Income
70
80
90
Spending
30
40
50
60
70
pen
din
g/M
onth
Less than $40k
Greater than $40k
0
10
20
3 Months 6 Months 9 Months
Sp
D bt Ch
60
70
80
th
Debt Change
20
30
40
50
bt C
han
ge/M
on
Less than $40k
Greater than $40k
-10
0
10
3 Months 6 Months 9 Months
Deb
Credit Limit
140
160
Spending
60
80
100
120
Spen
din
gLess Than $6k
$6k-12K
G t th $12k
0
20
40
3 Months 6 Months 9 Months
Greater than $12k
150
200
h
Debt Change
50
100
t C
han
ge/M
onth
Less Than $6k
$6k-12K
Greater than $12k
-50
0
3 Months 6 Months 9 Months
Deb
t
Card Utilization – Debt/Credit Limit
80
90
Spending
30
40
50
60
70
endi
ng/
Mon
th
Less than 50%
Greater than 50%
0
10
20
3 Months 6 Months 9 Months
Spe
D bt Ch
60
80
100
h
Debt Change
20
0
20
40
3 Months 6 Months 9 Monthst C
han
ge/M
onth
Less than 50%
Greater than 50%
-80
-60
-40
-20
Deb
t
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
300
350 329.99(113.05)
200
250
300
203.34(57.94)
257.21(41.96)
100
150
200 3 Month6 Month9 Month
0
50
100
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 rewardscards that provide rewards
Cash-back rewards are an effective tool for issuers to increase spending on a specific card (top of wallet)spending on a specific card (top-of-wallet)
APR reductions tend to shift more spending than cash-back rewards