Let Banks Set Rates

The Association of Banks in Malaysia recently announced a reduction in credit card interest rates of between 1.0 - 1.5% to interest rates ranging from 13.5% to 17% per annum. This means that card holders, who have a good credit record, defined as having made minimum payments promptly over 12 consecutive months, would now be paying only 13.5% p.a.

This seems reasonable to me, notwithstanding that Bank Negara's overnight rate is now at 2.5% p.a.

Thus, I do not agree with the call made by the Domestic Trade and Consumer Affairs Ministry yesterday to force banks to lower credit card interest rates further. A similar call is made today - not surprisingly - by P Gunasegaram, Managing Editor of the Business Section of The Star, in a comment entitled Credit Card Rates Can Be Lower.

There are three reasons why I am against this move.

Firstly, banks must be free to set their own rates. This is the most basic of free market principles. If the risk-reward equation is not palatable, banks will just tighten credit. And where will that lead us?

Secondly, running a credit card business is not as simple as what Mr Guna makes it out to be. It is not simply a matter of interest plus fees earned minus cost of funds minus default rate and voila! that's the profit margin of the bank. Mr Guna has failed to add in other salient costs including overheads, marketing and promotions and infrastructure cost that is relevant to any business.

Furthermore, in the credit card industry, especially in Malaysia, fraud risk is high and banks need to factor in that cost, including the cost for prevention. Mr Guna has also overlooked the important fact that many credit card holders are actually funded interest-free by banks from the period when the retailers are refunded to the point when the credit card holder actually makes payment, sometimes as long as 45 days later. The banks earn nothing from this group of credit card holders, what with the current competitive landscape which offers free cards and even throws in discount privileges.

Thirdly, further interest rate reduction will simply encourage more spending. Alright, the mantra we constantly hear in the current economic climate is "spend, spend, spend". But I would caution that we still need to spend responsibly. We do not want to entice spending that will lead to excessive debt.

I am all for helping current credit card debtors who are unable to settle their debts. The simple answer is discipline and debt restructuring. There is no easy way out.