A federal reserve study has found that less financially sophisticated consumers (and not just poor ones) are propping up the system for those that know how to profit from it.
Just in case you needed another reason to feel guilty about owning a credit card, researchers have dredged one up. That reason? Not only is owning a credit card liable to tempt you into buying things you can’t afford and get you into debt, but even if you are one of those people who use a credit card responsibly and benefit from the reward system’s perks, the only reason you are able to enjoy those privileges is because there are hordes of people getting rorted by the system and propping it up with their poor financial decisions.
According to a paper released by The Federal Reserve, consumers with high credit scores, who spend more money (and pay it back on time) and get more rewards like cash back or frequent flyer miles are having their lives of luxury subsidised by card holders with lower credit scores. These card holders with lower credit scores tend to spend more than they can afford to try and earn more points and then end up having to pay higher interest payments due to their outstanding balances.
According to the paper, some estimated US $15.1 billion is transferred each year from the poorly financially educated card holders to the better financially educated rich ones. This wasn’t even that correlated with income, but rather financial savvyness.
The researchers (a motley crew of economists at the National University of Singapore, the International Monetary Fund, the Center for Economic and Policy Research, and the Federal Reserve Board) thus theorised that the long standing “reverse Robin hood” theory, where the poor subsidise the rich, is incomplete, suggesting instead a theory centred around financial sophistication rather than mere income.
According to the research, reward cards made up for about 60% of all new cards in 2019. It also pointed out that banks usually offer lower interest rates on rewards cards than on cards without rewards, in order to attract new customers.
As Bloomberg reports, “Banks profit from reward cards across all credit scores, the researchers found, but they benefit the most from near-prime and prime card holders — those with fair or good-quality financial situations, according to the paper. With low credit-score customers, banks mostly generate revenue from interest payments.”
The study also concluded that the glinting ‘holiday in the Maldives’ type rewards card system encouraged consumers to overborrow compared to cards without fancy pant perks.