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Axing merchant fees for bankcards may hurt lenders
By Katie Chen |
December 6, 2012, Thursday
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Print Edition
Print Edition
THE People's Bank of China circulated a notice earlier in the month stating that the State Council had approved lower merchant fees for bankcard transactions, effective February 25. Bankcard merchant fees would be 1.25 percent for entertainment-related purchases, 0.38 percent for purchases related to daily living, and 0.78 percent for other types of purchases. Lower merchant fees are credit negative for Chinese banks because although the card business is a minor contributor to income and profits, lower merchant fees will undermine a promising channel for banks to grow their fee-based income.
We estimate that for the commercial banks we rate, the reduction in merchant fees would reduce their merchant fee income by nearly 30 percent and cause aggregate pre-tax profit to decline by 1.0-1.5 percent. During the first-half of 2012, bankcard fee income1 surged 36 percent year over year for the Chinese banks we rate, while total fee and commission income grew 6 percent. Without the increase in bankcard fee income, these banks' total fee and commission income would have risen only 0.4 percent because other fees, such as those related to consultancy and advisory services and lending, declined. Indeed, many banks have come to view their bankcard business as a key growth engine that will help offset the negative pressure on their lending business owing to lower interest rates and deregulation and help stabilize their more cyclical advisory and consulting businesses.
Currently, the merchant fees that banks and merchants negotiate average 1-2 percent depending on the type of purchases, including service fees charged by the banks issuing the cards, clearing institutions and the banks handling the payment for the merchants.
Increasing risks
The fee reduction threatens to increase the risks within banks' credit card loan portfolios in a number of ways. First, banks may try to accelerate volume growth to make up for the loss in fee income. Using the entertainment segment as an example, the reduction of merchant fee to 1.25 percent from 2 percent implies that banks would need a 60 percent jump in transaction volume just to maintain current income. This is far higher than the 36.6 percent growth recorded in the third quarter, and raises the risk that banks will adopt more aggressive competitive strategies, including lowering their underwriting and card issuance standards, to expand their volume.
Another risk is that banks may try to boost their bankcard fee income by promoting the usage of their cards for overdrafts or installment payments. Although credit card loans carry higher interest rates, the credit risk is also higher, given the customers who overdraft or borrow on the cards usually have weaker credit profiles.
We estimate that for the commercial banks we rate, the reduction in merchant fees would reduce their merchant fee income by nearly 30 percent and cause aggregate pre-tax profit to decline by 1.0-1.5 percent. During the first-half of 2012, bankcard fee income1 surged 36 percent year over year for the Chinese banks we rate, while total fee and commission income grew 6 percent. Without the increase in bankcard fee income, these banks' total fee and commission income would have risen only 0.4 percent because other fees, such as those related to consultancy and advisory services and lending, declined. Indeed, many banks have come to view their bankcard business as a key growth engine that will help offset the negative pressure on their lending business owing to lower interest rates and deregulation and help stabilize their more cyclical advisory and consulting businesses.
Currently, the merchant fees that banks and merchants negotiate average 1-2 percent depending on the type of purchases, including service fees charged by the banks issuing the cards, clearing institutions and the banks handling the payment for the merchants.
Increasing risks
The fee reduction threatens to increase the risks within banks' credit card loan portfolios in a number of ways. First, banks may try to accelerate volume growth to make up for the loss in fee income. Using the entertainment segment as an example, the reduction of merchant fee to 1.25 percent from 2 percent implies that banks would need a 60 percent jump in transaction volume just to maintain current income. This is far higher than the 36.6 percent growth recorded in the third quarter, and raises the risk that banks will adopt more aggressive competitive strategies, including lowering their underwriting and card issuance standards, to expand their volume.
Another risk is that banks may try to boost their bankcard fee income by promoting the usage of their cards for overdrafts or installment payments. Although credit card loans carry higher interest rates, the credit risk is also higher, given the customers who overdraft or borrow on the cards usually have weaker credit profiles.
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