The Cost of Being Late: The Case of Credit Card Penalty Fees

Abstract

This paper is the first in the literature to examine the determinants of US credit card penalty fees, which in 2004 amounted to $13 Billion, in a credit card market that had $800 Billion debt outstanding. Standard theory states that the price of debt should be related to default risk, yet many critics of credit card fees - including former presidential candidate John Kerry - have argued that credit card penalty fees reflect banks' market share. In this paper we examine, theoretically and empirically, credit card penalty fee pricing. Using a unique data set we find that credit card penalty fees are positively related to consumer default risk, measured at both the bank level as well as the macro level. However, we also find evidence that penalty fees are positively related to measures of bank market share. Our finding that fees are increasing in customer risk, supports the position of defenders of penalty fees such as banks. However, our finding that fees are increasing in market share is consistent with rent extraction, and the concerns expressed by politicians and regulators.