Fed Study: Banks Examine Credit Use When Considering Limit Increases

banker issuing credit card to customer

A new study from the Federal Reserve indicates that it’s not income levels or ability to repay that drives banks’ willingness to extend credit.

Rather, the use of credit — the engagement — is a significant factor in determining when, and by how much, credit limits are increased.

In the paper, titled “Income and the CARD Act’s Ability-to-pay Rule in the US Credit Card Market,” the Boston Fed noted that the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009 prohibits U.S. lenders from issuing loans that credit card borrowers lack the “ability to pay” (ATP).

“The act requires issuers to consider ATP when originating a credit card loan and when increasing the credit limit on a card,” said the Fed.

But it turns out, per the Fed data, that as shown by five large banks here in the states, the ATP rule is “generally not binding for credit-limit increases. Banks are more likely to increase credit limits on the accounts of cardholders who update their income, but whether income increases, decreases, or stays the same does not matter with respect to banks’ decisions to increase credit card limits, and the size of the change in income is practically unrelated to the change in credit limit.”

Other variables seem to matter more, according to the study.

What Banks Bank on When Extending Credit

“Accounts with more engagement, as shown by income updates, may be more profitable,” to the banks, according to the paper. The data show that cardholders using 40% to 50% of available credit, on cards with higher annual percentage rates, are more profitable, due to the active use of the cards that indicate that consumers are “not using so much credit as to indicate liquidity constraints that might lead to delinquency.” The Fed noted, too, that actual credit limits are “almost always substantially lower than reasonable ATP limits.”

Against that backdrop, we’d note that at least some margin of safety is in place. And separate Fed data indicates a few trillion dollars left in terms of spending power, left on those cards, before reaching limits. In the meantime, data from earlier this year show delinquencies are climbing across all tiers of credit and for a range of credit products, including mortgages, credit cards, personal loans and auto loans, according to the latest installment of VantageScore’s Credit Gauge. Early-stage delinquencies rose from 0.98% in January to 1.04% in February, marking the first time that figure has exceeded 1% in four years.

PYMNTS Intelligence found in terms of credit use, low-income consumers — those earning less than $50,000 per year — are more likely to consistently revolve their credit card balances, with 40% doing so, whereas 24% of those earning more than $100,000 per year do so.