RDP 2018-11: Consumer Credit Card Choice: Costs, Benefits and Behavioural Biases 1. Introduction

Consumers face economic incentives to hold and use credit cards, such as rewards programs or an interest-free period. Most research that seeks to explain consumers' decisions in the credit card market highlights these incentives, and finds they are important predictors of behaviour (Simon, Smith and West 2010; Ching and Hayashi 2010; Arango, Huynh and Sabetti 2015; Lam and Ossolinski 2015).

But some consumers also incur high net costs from their credit card, in both interest charges and fees. Behavioural biases have been discussed as a potential explanation for at least part of these high costs (Ausubel 1991; ASIC 2015, 2018; Australian Treasury 2016).^[1] Such biases may lead some consumers to choose credit cards with a high personal cost when lower-cost alternatives would have been available.

This paper estimates the net annual monetary cost or benefit that consumers receive from holding their credit card, and shows the distribution of these benefits and costs across different groups of consumers. Using these estimates, I test for the presence of behavioural biases and bounded rationality in the Australian credit card market. If they do affect card choice, these biases would likely reduce the value of the net benefit that consumers receive from their credit card relative to their optimal ‘rational’ choice.^[2] I focus on three aspects of the decision process when consumers choose which card to hold: consumers' predictions of their likely spending behaviour; their estimates of the value of their options; and, their responses to short-term sign-up offers. I also consider the potential for cognitive barriers to prevent consumers from switching to a different card after they have made their choice.

To facilitate this analysis, I use data from the 2016 wave of the RBA's nationally representative Consumer Payments Survey, which provide a unique and detailed (anonymised) picture of Australians' payment patterns and preferences. In 2016, new questions were added to the survey, asking about respondents' credit card use and repayment patterns, the factors that affected their choice of credit card, and their perception of the overall benefit or loss from holding their credit card. Combining these survey data with data on the universe of credit card offerings in Australia, I estimate the net monetary value of credit card features for each cardholding respondent in the survey.^[3] This estimate helps to answer two related research questions:

1. How are the monetary costs and benefits of holding a credit card distributed across different consumers?
2. Do behavioural biases appear to affect consumers' choice of credit card?

Footnotes

This issue has also attracted political attention recently, with the Australian Senate Economics Reference Committee's 2015 Inquiry into Matters Relating to Credit Card Interest Rates, and in discussions during the House of Representatives Standing Committee on Economics' Review of Australia's Four Major Banks. [1]

Note that a negative net monetary benefit does not directly imply that the respondent is ‘irrational’. Credit cards provide a payment service to cardholders; even abstracting from the credit function, we may expect consumers to be willing to pay a fee for this service. In addition, even if cardholders do not use their card to borrow, they may place some value on the option to access liquid funds in case of an emergency. [2]

My calculations are likely to overestimate the net monetary benefits, on average, that credit card holders receive, for reasons detailed in Section 4.3. However, this should not affect my main conclusions, which relate to the cross-sectional distribution of net monetary benefits. [3]