THE AMERICAN ECONOMIC REVEn MARCH 1991 TABLE 5-COMPONENTS OF PROFITS FOR MARYLAND BANK, NA Finance charges 1492 13.21% 158% Other customer charges 1.42% 1.17% Total revenue. Net charge-offs 109% 1.77% 1.80% rofi urces: Consolidated reports of condition and income (call reports), prospectuses, and registration statements for Maryland Bank, N.a. MBNA's credit card operations(and their An item-by-item profit calculation for profitability) are fairly typical of major is- MBNA is displayed in Table 5. As is typical suers, with the exception that the bank has for credit card issuers, the single largest stressed the concept of " affinity credit component of revenue is the finance charge cards, whereby cards are marketed to (which, for MBNA, derives from annual members of professional organizations, fra- percentage rates of 14.5-18.9 percent, de- ternal orders, and cause- related groups (with pending on the account). Despite the fact the organizations'endorsements). As a con- that the bank provides a 25-day grace pe- sequence, its interest rates are somewhat riod during which no finance charge is as- lower and its customers are somewhat more sessed if the account balance is paid in full redit-worthy than average. Indeed it may more than 80 percent of the banks credit interest readers that, during the period when card outstanding balances do accrue inter his article was undergoing the journals re- est. The drop in finance-charge revenues iew process, MBNA's marketing agent pro- displayed in Table 5 is largely attributable posed to establish an official American Eco- to the banks decision to reduce the interest nomic Association Visa card. This card rates on some of its accounts during would have carried a $20 annual fee($40 1985-1987 for a gold card)and an 189-percent annual MBNA also derives direct customer rey. ee: the AEa would have received s1 for enues from the annual fee and other each account opened, $3 for each account tomer charges(e.g, $15 late payment, over- renewed, and $0. 25 per retail transaction. limit, and returned-check charges). Indirect MBNA S agent estimated that 1, 000 cards revenues are derived from the interchange would be issued, generating $13 in revenue fee, the portion of the merchant discount per card per year for the AEA. However, that is paid to the customer's bank. It is the AEAs executive committee, concerned worth reemphasizing that the price sched that the aea" would be viewed as endors- ing a specific credit card by entering into such a contract, voted against establishing tary to the Executive Committee. I thank Orley Ashen the affinity card program. 9 felter and C. Elton Hinshaw for providing this informa A good rule of thumb mentioned in credit card ade publications is that 90 percent of i Draft minutes of the March 23, 1990, meeting of overall outstanding balances accrue interest. See the the AEA Executive Committee: Report of the Secre- discussion in Section VI-C. This content downloaded from 202. 120. 224.93 on Sun. 17 Dec 201707: 42: 57 UTC Allusesubjecttohttp:/about.jstor.org/terms58 THE AMERICAN ECONOMIC REVIEW MARCH 1991 TABLE 5-COMPONENTS OF PROFITS FOR MARYLAND BANK, N.A. Components 1985 1986 1987 Finance charges 16.66% 14.92% 13.21% Annual fees 1.40% 1.58% 1.29% Other customer charges 1.10% 1.42% 1.17% Interchange fees 3.06% 3.00% 2.92% Total revenue: 22.22% 20.92% 18.60% Interest expenses 9.57% 7.80% 7.13% Noninterest expenses 4.47% 4.71% 4.87% Net charge-offs 1.09% 1.77% 1.80% Total cost: 15.13% 14.28% 13.80% Return on assets (pretax profits expressed as a percentage of outstanding balances) 7.09% 6.63% 4.80% Sources: Consolidated reports of condition and income (call reports), prospectuses, and registration statements for Maryland Bank, N.A. MBNA's credit card operations (and their profitability) are fairly typical of major is- suers, with the exception that the bank has stressed the concept of "affinity credit cards," whereby cards are marketed to members of professional organizations, fra- ternal orders, and cause-related groups (with the organizations' endorsements). As a con- sequence, its interest rates are somewhat lower and its customers are somewhat more credit-worthy than average. Indeed, it may interest readers that, during the period when this article was undergoing the journal's re- view process, MBNA's marketing agent pro- posed to establish an official American Eco- nomic Association Visa card. This card would have carried a $20 annual fee ($40 for a gold card) and an 18.9-percent annual fee; the AEA would have received $1 for each account opened, $3 for each account renewed, and $0.25 per retail transaction. MBNA's agent estimated that 1,000 cards would be issued, generating $13 in revenue per card per year for the AEA. However, the AEA's executive committee, concerned that the AEA "would be viewed as endors- ing a specific credit card by entering into such a contract," voted against establishing the affinity card program.'9 An item-by-item profit calculation for MBNA is displayed in Table 5. As is typical for credit card issuers, the single largest component of revenue is the finance charge (which, for MBNA, derives from annual percentage rates of 14.5-18.9 percent, de- pending on the account). Despite the fact that the bank provides a 25-day grace pe- riod during which no finance charge is as- sessed if the account balance is paid in full, more than 80 percent of the bank's credit card outstanding balances do accrue inter- est.20 The drop in finance-charge revenues displayed in Table 5 is largely attributable to the bank's decision to reduce the interest rates on some of its accounts during 1985-1987. MBNA also derives direct customer rev- enues from the annual fee and other cus- tomer charges (e.g., $15 late payment, over- limit, and returned-check charges). Indirect revenues are derived from the interchange fee, the portion of the merchant discount that is paid to the customer's bank. It is worth reemphasizing that the price sched- 19Draft minutes of the March 23, 1990, meeting of the AEA Executive Committee; Report of the Secre- tary to the Executive Committee. I thank Orley Ashen- felter and C. Elton Hinshaw for providing this informa- tion. 20A good rule of thumb mentioned in credit card trade publications is that 90 percent of an issuer's overall outstanding balances accrue interest. See the discussion in Section VI-C. This content downloaded from 202.120.224.93 on Sun, 17 Dec 2017 07:42:57 UTC All use subject to http://about.jstor.org/terms