NONPRICE COMPETITION IN THE TURKISH CREDIT CARD MARKET

Abstract

I. INTRODUCTION High and sticky credit card rates that respond asymmetrically to changes in the cost of funds have been frequently cited in the literature.1 During the financial crises of 2000-2001 in Turkey, banks immediately raised their credit card rates from 107% in the last quarter of 2000 to 181% in the first quarter of 2001 in response to soaring short-term interest rates. However, in the recovery and stabilization period that followed, although other credit rates smoothly responded to falling short-term interest rates, credit card rates persistently remained high (Figure 1). There are 22 credit card issuer banks in Turkey. Although this number would normally suffice to secure a competitive outcome in a market for relatively homogeneous products, the mounting profitability of the credit card business and persistently high credit card rates make the matter a considerable concern for both policymakers and researchers. Our objective, in this regard, is to pinpoint the underlying reasons of this apparent lack of competition in the credit card market and to propose coherent regulatory policies. Explanations abound for the high and sticky spread between credit card rates and funding costs. The primary justification is that the uncol-lateralized nature of credit card loans leads to higher default risk and consequently to higher interest rates. Another is the noninterest bearing grace period from the day of purchase to the payment due date. Banks incur a cost to finance their customers' purchases during this time. Furthermore, operating a credit card system entails huge investments in technology and other infrastructure. Small average balances, on the other hand, preclude the cost-effective collection process. Liquidity risk management, which is necessitated by banks' obligation to be ready to lend up to the full amount of the issued credit cards' limits at any time, also requires costly measures. In addition, banks may also increase their costs in efforts to differentiate their products through the distribution of benefits such as money points and other rewards. (2) By and large, the persistently high profitability of the credit card business, despite fluctuations in the above mentioned costs, suggests that inherent costs can only partially account for high and sticky credit card rates (Ausubel 1991). [FIGURE 1 OMITTED] There also exist some more sophisticated explanations. Chakravorti (2003) associates credit card rates with the proportion of convenience users to revolvers. Because banks subsidize convenience users and earn interest incomes only from revolvers, the higher the ratio of convenience users, the higher the banks' costs are. Ausubel (1991) classifies cardholders according to their rationality and how they use their credit cards. He then postulates that when banks are unable to observe cardholder types, they become reluctant to unilaterally lower their card rates for fear of attracting only adverse types. Calem and Mester (1995) and Stango (2000, 2002) emphasize the cost of cardholders switching to banks with lower rates. Mester (1994) and Park (2004) argue that sticky rates might be an equilibrium response to banks' asymmetric information about cardholders' future incomes. Using the Panzar-Rosse technique, Shaffer and Thomas (2007) demonstrate that banks are engaged in monopolistic competition in credit card markets and thus obtain monopoly power through differentiation. Shaffer and Thomas' account certainly holds for the Turkish market. Credit cards are by no means homogeneous products. Although there exists no price competition in the market (Akin et al. 2010), banks are actively engaged in fierce nonprice competition. To acquire market power, banks differentiate their cards by providing an array of card level benefits such as travel miles, bonus points, rewards, shopping discounts, the possibility of paying in installments, and travel and accident insurance. …