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A review by the Federal Reserve Bank of Chicago Business Conditions Bank credit cards 8 Federal Reserve Bank of Chicago OF BUSINESS The economy at m id year 2 Halfway through 1972, it is clear that the substantial gains in economic activity fore seen by the more optimistic forecasters at the start of the year are being achieved. A rise of at least $100 billion, or 10 percent, in the gross national product (total spend ing on goods and services) now appears probable. This would be the largest per centage advance since 1951, the first year of the Korean War. After adjustment for price inflation, the increase in activity this year is now expected to approach 6 percent —the largest gain since 1966. Only six of the 27 years since World War II have seen larger increases in total output. The base of the recovery has broadened in the past 18 months. In the first half of 1971, residential construction led other sec tors on the road back to prosperity. In the late summer and fall of 1971, sales of autos and other consumer durable goods increased sharply. In the first half of 1972, orders for machinery and equipment accelerated. The sequence of revival in these sectors— housing, consumer durables, and business equipment—follows the pattern established in earlier recovery periods. The momentum and breadth of the business upswing in mid-1972 was such that a growing number of analysts have become convinced that sizable gains in the third and fourth quarters are “in the bag.” As a re sult, recent discussions of the economic outlook have shifted to consideration of prospects for 1973. Economic analysts usu ally do not turn to “next year” until Sep tember or later. All major industrial areas of the Midwest are sharing in the national advance in ac tivity, although not always to the same de gree. In addition, farm income is running well ahead of last year because of sharply higher prices for crops and livestock. Pros pects for substantial gains in farm income and output for 1972 as a whole are excel lent. Farmer optimism is reflected in higher expenditures for farm equipment and other production needs. Despite increases in activity, resources of manpower, raw materials, and facilities re main ample in most sectors. Except for spe cial situations, e.g., heavy trucks, hides, and beef, most finished goods and materials are readily available. Coupled with substan tial increases in output per man-hour, the absence of bottlenecks has aided the efforts of the Price Commission to hold the rate of price inflation in check. Business Conditions, July 1972 One commonly used measure of the in flation rate is the change in the “implicit price deflator.” This indicator is the ratio of total gross national product to what it would have been if 1958 prices and wages still prevailed in all parts of the economy. The average value for this deflator prob ably will be less than 4 percent higher this year than it was in 1971. This would be the smallest rise since 1967. Last year, the de flator increased 4.7 percent. In 1970, the peak year of the Vietnam inflation, it rose 5.5 percent. M an u factu rin g up s h a rp ly In June 1972, activity in mining, manu facturing, and utilities as measured by the Federal Reserve Board Index of Industrial Production was 0.7 percent above the 1969 high. This is about 5 percent above a year Manufacturing output in sharp rise, but durable goods remain below 1969 peak percent, 3Q 1969 =100 1969 1970 1971 Note: FRB Indexes of Manufacturing Output. earlier and represents an annual growth rate since September 1971 of about 8 per cent. However, the manufacturing compo nent of output was still 0.4 percent below the high reached in July 1969. This was a sluggish performance relative to the prog ress of the total economy, and relative to past experience in manufacturing. The gross national product, in dollars of constant pur chasing power, was about 6 percent higher in the second quarter of 1972 than the peak rate reached in the third quarter of 1969. Manufacturing activity has lagged GNP in each previous recovery since World War II, but not to the same degree. In each cycle, manufacturing surpassed its pre-recession peak within two years, and in much less time in some cases. A number of factors account for the rela tively poor performance of manufacturing relative to the economy as a whole since 1969: First, the sectors that declined the most and have recovered the least—business equip ment and defense equipment—comprise a much larger share of manufacturing than of GNP. Second, in 1969, U. S. merchandise exports slightly exceeded imports. But in 1971, and thus far in 1972, imports have exceeded ex ports. The shift in the trade balance may have adversely affected manufacturing ac tivity in the United States. Third, business inventories of goods rose by more than $7 billion in 1969, compared with about $2 billion in 1971, and the rate of ac cumulation has remained low in the first half of 1972. A faster rate of inventory accumula tion in recent months would have meant a higher level of manufacturing activity. 1972 All three of these factors depressing manufacturing output probably are in the 3 Federal Reserve Bank of Chicago process of being reversed. Output of busi ness and defense equipment is rising. The unfavorable merchandise balance in inter national trade is expected to improve. Fi nally, inventories are almost certain to rise at a faster pace in the remainder of 1972 and in early 1973. D u rab les an d n o n d u ra b les 4 The varying impact of the recession and the extent of recovery are depicted vividly in the trend of output of major groups of manufacturing industries. Total manufac turing output declined 10 percent from the 1969 high to the low point marked by the General Motors strike in late 1970. By June 1972, virtually all of the lost ground had been regained. In various industries, output dropped much more than the total in 1970, while in other industries the decline was much less. In some industries, activity now is at a new high, while others are still op erating at levels well below earlier highs. Manufactured products are classified either as durables or nondurables. The for mer are “hard goods” composed principally of wood, metal, stone, or ceramics. Non durables include “soft goods,” such as cloth ing and carpets that may have a relatively long life, as well as foods, chemicals, and petroleum products that usually are con sumed soon after purchase. Durable goods typically are long-lasting, “big ticket” items that are purchased only periodically, often with the use of credit. For these reasons, purchases of durables are often postponable. Most nondurables, on the other hand, are purchased more or less continuously. Despite strong output trends in such sec tors as building materials, autos, and house hold furnishings, the total durable goods output was still 6 percent below the 1969 high in June 1972. Total output of nondur ables goods, in contrast, declined only 3 percent in 1969-70, reached a new high in the spring of 1971, and in May 1972 was 6.5 percent above its 1969 peak. D efense an d sp ace Within the durable goods grouping, out put of defense and space equipment was the hardest hit in the recent recession. Be cause reductions in arms procurement were a result of altered government policies, these cutbacks were a cause rather than an effect of the recession. Defense and space equipment output reached a peak in September 1968, a year before the high in total manufacturing. By the first quarter of 1972, output of these industries was down one-third. Even with out secondary effects, the decline in defense and space output would have meant a drop of more than 3 percent in total manufac turing. But, of course, there were secondary effects, as defense contractors and former defense employees were forced to curtail outlays as their incomes declined. In recent months, defense output has be gun to revive. The uptrend is expected to continue, despite the recent agreements to limit the nuclear arms race. After a long drought, a number of Seventh District firms recently have been awarded defense con tracts for aircraft components and ord nance. But defense is only about half as im portant, relatively, in the Midwest as in the nation. Business equipment is another story. Surge in business eq u ip m en t Midwest centers are much more con cerned with the prospect for equipment pur chases by civilians—both consumers and businesses—than trade in defense or aero space. With 16 percent of the nation’s popu lation, the five Seventh District states— Business Conditions, July 1972 In the first five months of 1972, truck sales Illinois, Indiana, Iowa, Michigan, and Wis were almost 40 percent above last year’s consin—produce two-thirds of its output record level. Heavy trucks are especially of farm machinery, almost half of its con strong, with capacity limiting availability of struction machinery, about two-thirds of its some major components. Producers now ex motor vehicles and TV receivers, one-third pect to sell a record total of 2.5 million of its household appliances, and more than trucks this year—up from the previous high one-fifth of its furniture. of 2.1 million set in 1971. Most major pro Sales and output of all major classes of ducers of trucks and components are press consumer durables—motor vehicles, mobile homes, motor homes, appliances, TV sets, ing expansion plans, because demand has furniture, and recreational equipment— outrun expectations. have been strong since the late summer of Sales of farm machinery were about one1971. In part, strength in home furnishings third above last year in the first five months. reflects the high rate at which new dwelling Certain types of construction equipment are units have been completed. Although con showing similar spectacular gains. Other in sumer outlays continue strong, further sub dustries reporting substantial improvement stantial gains in sales of these items are include electric motors, materials handling unlikely in the next two or three quarters. equipment, and shipbuilding. Even orders In contrast to consumer equipment, de for machine tools are up sharply from last mand for business equipment remained year’s reduced level. sluggish through most of last year. From the 1969 peak to the low point in early 1971, output Large gains expected in of business equipment declined expenditures on new plant 15 percent. This output rose and equipment slowly and erratically in 1971. percent change Since last January, however, the 12 8 4 - 0 + 4 8 advance has been steady and I—I—I—I—I—r~ fairly rapid. In the four months 1970- 71 all industries ending in May, business equip 1971- 72 ment output rose at an annual | ~ rate of more than 13 percent. durable goods mfg. Nevertheless, output of these industries in May was still 8 per nondurable goods mfg. cent below the 1969 peak. New orders and order back public utilities logs for business equipment have been increasing steadily this year, but the situation has varied all other ! widely from sector to sector. By far, the most vigorous expansion ‘ Estimate. by class of equipment has been SOURCE: Department of Commerce. trucks, both light and heavy. Federal Reserve Bank of Chicago Strength in capital goods demand mainly represents replacement and modernization outlays to improve operating efficiency and product quality. Demand for heavy equip ment for basic industries—steel is the prime example—is still quite slow. Demand for railroad equipment has failed to pick up, as expected, despite obvious needs for replace ments. But the financial difficulties of major railroads may be alleviated by gov ernment loans or subsidies. The uptrend in business equipment has been aided by liberalized depreciation rules and the restoration of the investment tax credit in 1971. Even without these induce ments, however, improved liquidity, rising profits, and, most important, the revival of sales and orders probably would have brought a revival in business investment. In ven to ries rem a in lo w 6 While expenditures on business equip ment were increasing at a faster pace in the first half of 1972, the rate of investment in business inventories remained slow. At the end of May, the book value of manufac turing and trade business inventories totaled $184 billion, up 3.5 percent from a year before, while wholesale prices were up about 4 percent. Business sales in May totaled $122 billion, up more than 10 percent from the year-earlier level. Because business sales have increased faster than inventories, the inventory-sales ratio was only 1.51 in May, down from 1.60 a year earlier. The April-May inventorysales ratio was the lowest since October 1966, and about the same as the average for the period since World War II. In manu facturing, the inventory-sales ratio at 1.69 in May, compared to 1.85 a year ago. Some writers have referred to the failure of inventory investment to accelerate as Inventories remain low relative to business sales ratio of stocks to sales 1972 Note: April data. one of the “weak spots” in the economy. Quite the contrary, rapid inventory build ing, with rising inventory-sales ratios, is inherently temporary, and, therefore, a source of instability in a business expansion. In light of recent developments, more rapid inventory building appears likely to be a growing factor in any further acceleration in general activity. The possibility exists that inventory building would become ex cessive and create uncertainty as to the duration of the uptrend in 1973, but in judging the nearer-term outlook, the mod erate rate of inventory investment must be counted as a factor of strength. On the basis of historical relationships, inventory investment is likely to rise from the slow pace of recent quarters to an an nual rate of $10 billion or more in late 1972 and early 1973. In recent months, however, Business Conditions, July 1972 some business firms have continued policies of reducing inventories further, or at least are keeping a tight rein on expansion. Man agers emphasize better inventory controls through improved planning, computer ac counting, more efficient warehousing, and use of air freight and other rapid means of delivery. Some firms have been able to cut inventories because they have shortened product lines, and are offering a narrower product selection to customers. The fact that inventory management techniques have improved is significant. But there are other considerations. Low inventories appear adequate so long as new supplies and components can be obtained from vendors on relatively short delivery schedules, which can be expected to be maintained. If order lead times continue to lengthen, however, and if shortages of cer Unit labor costs continue to rise as compensation gains exceed productivity increases percent, 1967 =100 1968 1969 1970 1971 1972 tain vital supplies and components develop, additional quantities may be ordered as a precaution. This process may become cu mulative and help create shortages. Su m m ary As the third quarter begins, the business expansion appears to have the momentum required to sustain an uptrend through the year and into 1973. Consumer spending re mains vigorous, expenditures on business equipment are increasing, and some gov ernment programs are expanding at a faster rate. With the possible exception of resi dential construction, activity in all major sectors of the economy is either stable or rising. Although unemployment rates re main relatively high, employment has in creased steadily and rapidly since last fall. Despite recent increases in prices of meat, hides, and some building materials, the gen eral price level is advancing at a slower pace than at any time in the past four years. Whether price inflation will remain in check as the gap between actual and potential ac tivity narrows in the months ahead is not clear. Rising output per man-hour is help ing to offset the pressure on the price level generated by rising spending. But labor costs per unit of output have continued to climb, although at a slower rate, because average increases in compensation have continued to exceed gains in productivity. Cost-push inflation is still present, there fore, and demand pressures are building on a broad front. A testing period lies ahead. 7 Federal Reserve Bank of Chicago Bank credit cards 8 Millions of Americans now carry embossed plastic cards issued by banks that represent power to purchase an ever-widening range of goods and services. Bank credit cards are used to buy clothing, hardware, appliances, furniture, recreational equipment, and gaso line. They also are used to pay for restau rant meals, car rentals, airline tickets, hotel rooms, and medical services—even to make charitable contributions and to obtain cash advances. Growing acceptance of the cards by vendors and consumers has made it pos sible for people to acquire most of the neces sities and comforts of life—and to travel throughout the nation—without handling cash or writing checks. The reckoning comes later, when the monthly bill arrives by mail from the card-issuing bank. Bank credit cards have become firmly entrenched in the nation’s payments mech anism in recent years. Moreover, the tech niques developed in handling bank card credits and payments may be helping to create the “cashless, checkless” society en visaged by those who believe the existing system of payments is archaic and behind the pace of advancing technology. Recent progress of bank credit cards has largely overcome earlier doubts about their viability—doubts that were associated with the faltering beginnings of pioneer plans in the 1950s and early 1960s. A welter of in dividual bank credit card plans, largely un coordinated, has been superseded in large part by two national systems—BankAmericard (National BankAmericard Inc., NBI) and Master Charge (Interbank Card Associ ation Inc.). The “Big Two,” growing and competing side by side, have developed na tionwide credit slip clearing facilities. Op erating under essentially similar arrange ments and regulations, the two systems1 now include about 1,200 card-issuing banks and 8,000 agency banks. (There are about 13,500 commercial banks in the country.) They have more than 20 million active card holders, whose cards are honored by more than 1 million merchants and businesses. About 200 independent bank card plans are still operating, mostly quite small. The Big Two now account for more than 90 per cent of total receivables outstanding. Ap parently, few independent plans are being launched, and existing independent plans are still converting to the national systems. The parent organizations of BankAmeri card and Master Charge are headquartered, respectively, in San Francisco and New York. They stand ready to franchise (BA) or to license (MC) qualified banks that agree to pay fees, to file periodic reports, and to operate by broad rules and regula tions. Card-issuing banks have wide latitude in their relations with cardholders and mer chants and in methods of operation. Fran chises or licenses are not exclusive for given territories, but entry has become more diffi-* ’At the end of 1971, the BankAmericard group reported 246 card-issuing banks, and $1.8 billion in receivables outstanding; the Master Charge group reported 981 card-issuing banks (defined as those that hold 100 percent of receivables) and $2.3 billion in receivables. Business Conditions, July 1972 cult as card plans have blanketed the nation and card-issuing banks have gained in expertise. Recent ra p id grow th At the start of 1972, $4.5 billion of re ceivables were outstanding on bank credit cards, up 18 percent from a year earlier. As recently as 1967, receivables outstanding were only $830 million. Sales of goods and services and cash advances on bank cards in 1971 were about double average outstand ings, or $9 billion. On the basis of results in the first half of 1972, informed bankers be lieve that outstandings and transactions on bank cards will increase at least 20 percent in 1972. Total consumer instalment credit out standing at commercial banks amounted to $55 billion at the end of 1971. Of this, 8.2 percent represented outstandings on credit cards. This proportion has increased steadi ly. At the end of 1967, it was only 2 percent. For card-issuing banks, the share of con- Bank card outstandings have increased markedly since 1967 billion dollars .5 r 1967 1968 1969 1970 1971 Bank cards account for a rising share of bank instalment and total consumer credit percent 10 year-end figures bank instalment c r e d i t ^ — "* 8 7 r 6 - 5 4 / total consumer credit - 3 2 O 1967 ___ i__________ i__________i__________ i 1968 1969 1970 1971 sumer credit accounted for by card credit is, of course, much larger than for all banks. Outstandings on bank cards at the end of 1971 were only about 3.3 percent of all consumer credit outstanding—instalment, single-payment, charge account, and service credit. This proportion had increased each year since 1967, when it was less than 1 per cent. But this comparison greatly under states the relative importance of bank credit cards in the sectors they serve. Bank cards play a small role in such im portant types of consumer credit as instal ment loans for the purchase of motor ve hicles, mobile homes, recreational vehicles, home improvements, and bills owed to doc tors and public utilities. Bank cards are closely competitive with instalment credit, revolving credit, and charge accounts pro vided by merchants, and with oil company and “travel and entertainment” (T&E) credit cards. Outstandings on bank cards Federal Reserve Bank of Chicago now probably account for 15 to 20 percent of all consumer credit in their scope of op erations. This share has been growing yearly. Bank card s in th e M id w est A few Seventh District banks, mainly in Michigan, established credit card plans in the 1950s. But banks on the West Coast and in the New York area led the develop ment of large volume credit card banking. In 1966, several large Chicago banks de cided to launch a cooperative plan known as the Midwest Bank Card System. In their haste to sign up merchants and consumers, some bank card issuers, in Chi cago and elsewhere, encountered many problems that were alleviated, or overcome, only through concentrated effort over a period of years. A large number of unsolic ited bank cards were mailed to hurriedly drawn lists of prospects. (This practice was outlawed in the Consumer Credit Protec tion Act passed by Congress in October 1970.) Losses on receivables owed by poorly screened card users and losses on fraud as sociated with stolen cards were heavy in the 1960s. Processing credit data and sales slips proved to be unexpectedly difficult, and expensive. In 1969 and 1970, most of the large card issuing banks in the Seventh District joined either the BankAmericard or Master Charge systems. At the end of 1971, 258 Seventh District banks (about 10 percent of the total) issued cards or participated in hold ing receivables. Total outstandings on credit cards issued by district banks were $450 million at the end of 1971, 10 percent of the national total. This ratio had not changed much in two years. Since the Sev enth District accounts for about 16 percent of the nation’s personal income, and about 16 percent of total bank loans and invest ments, the Seventh District is behind the nation in credit card use. Credit card usage is heaviest in the San Francisco Federal Reserve District, dom inated by California where bank cards got an early start and expansion was fostered by extensive branch banking. The San Fran cisco District still accounts for 25 percent of the nation’s bank card receivables, but this is down from 50 percent in 1967. Bank card use is also relatively large in the North east, the South, and the Southwest. About 80 percent of the bank card re ceivables in the Seventh District are held by ten banks. Some of these banks have 100 or more affiliated banks, which may be lo cated in states other than the card-issuing bank. Affiliates may participate in a portion of the receivables generated by the card holders of the card-issuing banks. Others Business Conditions, July 1972 Michigan banks lead the Midwest in bank card receivables percent of district outstanding 50 bank credit cards total loans 40 30 20 I0 0 Illinois Indiana Iowa Michigan Wisconsin act only as agents, accepting the deposit of sales slips from merchants and forwarding these to their correspondents. Usually agent banks handle their own merchants’ deposits and service these accounts, while the card issuing banks hold and service cardholders’ receivables. Affiliated banks are important to card issuing banks that do not have extensive branch systems. Agency banks, often too small to have their own plans, help sign and hold merchant accounts and make cash advances to cardholders—the latter func tion is restricted to banks. Illinois remains a unit bank state, while Indiana, Iowa, M ichigan, and Wisconsin restrict new branches to a defined area in the vicinity of the parent bank. R ela tio n s w ith card h o ld ers Application blanks for bank cards are prominently displayed on merchants’ count ers and in bank lobbies. In addition, banks make extensive use of direct mail solicita tions. Cards are now issued only after care ful credit checks, so careful, in fact, that possession of a bank card often is useful as a reference when cashing checks or obtain ing other types of credit. Bank cardholders tend to have higher incomes and more edu cation than the population as a whole. Many cardholders have two bank cards, just as they may have two or more oil cards. Banks may issue cards to individuals in any state, but they usually restrict new cards to their normal marketing areas. Bank cards are issued for limited periods of time, usually one or two years, with expi ration dates embossed on the face. Card holders are assigned credit limits—as low as $300, but often more—which may be raised after favorable experience. The name of the card-issuing bank appears on the card (either front or back), but it may be incon spicuous. As a result, cardholders may be unaware which bank holds their accounts. Each vendor is assigned a “floor limit” for bank card purchases. Sales in excess of this amount, generally $50, must be author ized by the bank, through a phone call. Smaller transactions are conclusive and ir revocable when the customer signs the sales slip. Authorizations are recorded against the Unexpended balance of the cardholder’s credit line. If a new transaction would cause a cardholder’s balance to exceed his credit limit, bank officials may raise the limit. Experiments are under way with electronic “point-of-sale” authorization systems in which clerks insert bank cards into a device that communicates with the card-issuing bank’s computer. Under these systems, there may be a “zero limit,” and all transactions are added immediately to the cardholder’s outstanding debt. Although expensive to in stall and operate, a nationwide network of such devices would greatly increase the ef- 1 Federal Reserve Bank of Chicago 12 ficiency and improve the security of the bank card systems. Cardholders are billed monthly. The bill lists the amount due, the billing date, and other pertinent information, and is accom panied by the sales slips or itemized listing of transactions. If a cardholder pays his bill within the grace period, usually 25 days from the billing date, no finance charge is incurred. Cardholders may receive free credit for two months or more from the date of transactions because of the time consumed in processing, transporting, and billing sales vouchers. Cardholders wishing to use the revolving credit feature of their bank cards may make monthly partial payments, which may be an amount related to the credit line or a per centage of the outstanding balance, usually 5 percent. Debts outstanding beyond the due date are assessed a finance charge, com monly 1.5 percent per month, or an effec tive annual rate of 18 percent. Laws in some states limit the finance charge on such debts to lower rates. Most banks maintain they cannot operate card plans profitably at rates lower than 18 percent because of the relatively low average outstanding amount. For one thing, credit criteria must be more restrictive and volume, therefore, is cur tailed. As a result, bank cards typically have not flourished in states with low rates. The average outstanding balance on ac tive bank cards is about $250. The most profitable cardholder accounts, of course, are those with large balances that are car ried beyond the grace period. In most banks, less than 50 percent of sales volume be comes subject to finance charges. Bankers find it difficult to make profits on card plans, overall, when the proportion of cardholders paying accounts within the grace period is substantially more than half. “Sophisticated” cardholders, especially those who use cards for business expenses, not only pay on time, but delay payment as long as possible, in the same manner as corporate disbursing officers who seek to economize on cash balances. R elatio n s w ith ven d o rs Bank cards have been a boon to many merchants, especially smaller firms, who are now able to sell on credit to a much larger number of potential customers and compete with larger stores. Similar advan tages are offered by the travel and enter tainment cards, but those plans do not usually provide immediately available funds, and discounts paid by merchants are larger than for bank card plans. To compensate banks for their services, vendors are charged discounts on the dollar volume of their bank card sales that usually range from 1 to 6 percent, with an average of less than 3 percent. The amount of the vendor’s discount is determined by negotia tion. The discount percentage may depend partly on sales volume, but the most im portant factor is the average size of the sales tickets. The higher the average sales ticket, the lower the rate of discount. Costs of handling a sales ticket for 50 cents are as large as for one of $50. Merchants and other businesses that honor credit cards usually continue to main tain accounts at banks whose customers they had been prior to entering the plan. If they accept two bank cards, an increas ingly common practice, vendors usually must maintain at least two bank accounts. Sales slips are deposited by vendors with other receipts in their banks. If the bank is an agency bank, it sends the slips to its correspondent who sorts and distributes the slips to the various card-issuing banks on Business Conditions, July 1972 this action may have offended some old customers. Because sales slips are nonnegotiable, there is little danger of loss through theft or robbery. Card-issuing banks do not set a minimum size for sales tickets, but some vendors may set a lower limit—such as one dollar. Over all sales tickets on bank cards average about $17 to $18. Gas station sales slips average about $8, while airline ticket sales average about $100. The development of travel and entertain ment cards and oil company credit cards paved the way for the Big Two bank card plans to operate on a national scale. To day, stations of almost all major oil com panies, most hotels, and most higher-priced restaurants honor bank cards. Also, the cards are widely accepted by variety stores, discount department stores, and specialty stores, and many service establishments. Conspicuous among the types of stores that do not accept bank cards are large department stores and grocery chains. Executives of The two national bank card large department stores believe systems expanded in 1971 their own credit arrangements preferable overall, and help hold $6.9 billion 1970 their customers. Moreover, they credit extended value the opportunity of sending $8.3 billion “stuffers” to customers along $3.6 billion with bills. In the case of large amount outstanding! $4.1 billion food chains, pre-tax profit mar gins are about 2 to 3 percent of sales, and a discount could not active accounts be passed on to customers unless the practice were general. (Food card-issuing and chains frequently honor bank agency banks card s fo r non -fo o d item s.) Nevertheless, experiments are under way in a number of de merchant outlets partment stores and food stores to determine whether card plans which they are drawn. Sales slips of the major plans are treated as cash, i.e., im mediately available funds. Risks on the re ceivables are borne by the card-issuing bank, which may share receivables and risks with agency banks that are also “par ticipating” banks. Vendors have certain obligations. Aside from getting authorizations for sales over the floor limit, they should check customers’ signatures with those on the card, and com pare card numbers with those appearing on the current revoked card list. Because bank card credit slips are the equivalent of cash, many participating mer chants find them preferable to customers’ checks or to regular charge accounts. Ex penses of credit investigations, bookkeeping, and collections are assumed by card-issuing banks. As a result, smaller merchants fre quently have abolished their own charge systems in favor of bank-cards, even though 13 Federal Reserve Bank of Chicago would add to profits by increasing customer purchases. If the average sale is increased by credit cards, merchants may be able to absorb discounts without raising prices. One problem for vendors honoring credit cards is the possibility that customers may demand a discount for cash. This practice is frowned on by the banks, who maintain that it violates the Truth-in-Lending Act under which terms of trade must be pub licized and available to all customers. Profit and loss 14 Are credit card plans profitable to banks? The answer varies, but a majority of bank card plans, when fully costed, probably are not in the black at the present time. If card plans are profitable, are they as profitable as the bank’s operations as a whole? The answer is generally “no.” Is the potential profitability of bank card plans promising? The answer is an emphatic “yes” from some bankers and an equally emphatic “no” from others. Responses to a survey of commercial banks taken by the Federal Reserve System in August 1971 showed that only 25 of 82 banks that reported earnings and expenses on credit cards calculated a profit on this operation in 1970. Several banks indicated that they either could not determine profit ability precisely or did not believe their re sults could be compared with the experience of other banks because of differences in ac counting. Most of the banks responding to the survey reported, however, that they ex pected either higher profits, or lower losses, in 1971. Some banks believe that they are doing better on bank cards in 1972 than in 1971. Significantly, only two banks (not Seventh District banks) in the survey report ed they intended to drop their card plans. Profitability of card plans depends in part on the time the plan has been operat ing because start-up problems are inevit able. Total volume is important to achieve economies of scale, but profitability also depends to a larger degree on efficiency of operation, and on the characteristics of cardholders and vendors serviced. Like other corporations, banks are not required to report profits or losses by de partments. However, profit-minded bank executives often insist on such evaluations for internal purposes. In the case of card plans, there are important differences in the way bank accountants treat revenues and expenses. On the expense side, bank accountants differ as to the manner in which they charge departments for space, how they allocate overhead, and how they determine the rate at which departments are charged for funds used. On the revenue side, banks differ in the manner in which they credit operations of various departments with compensating balances, and the extent to which credit is given for new business brought in to other departments (or business retained) because of card plans. Contrary to a widespread impression, bad debt write-offs do not account for the bulk of card plan expenses. Such charge-offs amounted to 3 percent of average outstand ings in 1970. Within this total, fraud losses were about 0.6 percent nationally. Costs of funds, which may vary widely with money market conditions, and operating expenses are much larger than charge-offs for most bank card plans. Start-up costs probably doom any new card plan to losses for the first two or three years or more. As volume expands, lists of cardholders are “shaken down,” and costs of operations are brought under control— especially the processing of the huge volume Business Conditions, July 1972 of sales slips—profitability may be achieved. Through a variety of techniques, banks have been able to reduce substantially “mail fraud” losses resulting from cards being stolen before they reached the intended re cipient. Lost or stolen cards (other than mail fraud) will always be a problem, but here again techniques have been developed to minimize unauthorized charges. Prompt notification is, of course, essential. Use of pictures on cards to prevent unauthorized use may become general, but improvements in techniques of manufacture and cost re ductions are essential. Federal law has limited a cardholder’s liability for use of a lost or stolen card to $50 since early 1971. But most banks had been absorbing such losses before the legislation, unless there was evidence of extreme care lessness or collusion. Banks typically do not press cardholders for the $50 liability on lost, stolen, or improperly used cards. Card-issuing banks are unanimous in their attitude toward prosecutions for fraud. They are prepared to push charges to the full extent of the criminal law. Im pro vin g th e p ro fit picture Banks have been able to improve profits or cut losses on card plans by screening ap plicants more carefully, by eliminating in active consumer accounts, and by eliminat ing low-volume vendors. In formulating these policies, there is a continuing balanc ing of risks against possibilities of gains. New equipment and improved operating methods have reduced costs of handling sales slips. To increase credit card income, banks can raise vendor discounts when competitive conditions (and the Price Commission) per mit. Another method is to raise loan limits of established card users to increase average outstandings. Some banks are experiment ing with programs that combine check credit plans, overdraft privileges, and instalment loans in a single package. If the average credit outstanding for individual cardhold ers can be raised to $400 or $500, profits would increase dramatically. Profitability might be increased by charg ing annual fees for cards (as travel and en tertainment plans do) or by shortening grace periods. But such steps would be taken re luctantly because of the possibility that card usage would be adversely affected. Currently, banks operating card plans are concerned about legislation pending in Con gress that would require changes in their operations, especially in billing practices, that would be costly. They believe enforce ment of some proposed consumer protection measures could increase operating costs and reduce potential profitability of card plans. Further gro w th assu red Most of the largest banks, and many smaller banks, have committed substantial resources—funds, facilities, and manpower —to bank card programs. Credit outstand ing on the cards has accounted for a steadily growing share of total consumer credit, and this trend probably will continue. Certain large banks have examined the possibilities of card plans periodically and have decided not to enter the field. They foresee no substantial profit opportunities in these plans. Usually, these banks main tain that a credit card program does not fit their plan of operations and that their cus tomers—consumers and vendors—do not desire this service. Despite the holdouts, it is apparent that credit card banking is firmly established on a broad national base. Virtually all qualified consumers and ven dors can obtain these services from one or 15 Federal Reserve Bank of C hicago more local banks. Bankers who are enthusiastic about the future of bank cards expect the plans to assume a growing role in consumer finance. They foresee a time when most consumeroriented services of banks—loans, deposits, and checking—will be consolidated with the bank card plan as the focal point. BU SIN ESS C O N D IT IO N S is p u b lish ed m o n th ly b y the F e d e ra l R eserve B a n k o f C h ic a g o . G e o rg e W. Cloos w a s p r im a rily resp o n sib le fo r the a rtic le "T h e trend o f b u sin e ss—the econo m y at m id y e a r" a n d G e o rg e W . Cloos an d E d w a rd W . B irg e lls fo r " B a n k cre d it c a rd s ." Su b scrip tio n s to Business Conditions a re a v a ila b le to the p u b lic w ith o u t c h a rg e . For in fo r m atio n concern ing b u lk m a ilin g s , a d d re ss in q u irie s to the R esearch D e p a rtm e n t, F e d e ra l 16 R eserve B a n k of C h ic a g o , B o x 8 3 4 , C h ic a g o , Illin o is 6 0 6 9 0 .
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