Developments in the US market

Market saturation In recent years
the UK has been a target market for
US credit card companies. Their
interest in the UK market may in
part reflect the fact that the UK
credit card market is highly concentrated;
a relatively limited number
of providers control a significant
percentage of the market share. By
contrast, there is far lower concentration
in the US and the credit card
market is approaching saturation.
Any recent growth in the US
has been based on either winningover
customers or exploiting niche
markets, which could include highrisk
customers. Although “balance
transfer” was the approach favoured
by US card issuers in the US market,
as competition has increased, it is no
longer as popular. There are high
acquisition costs in trying to “poach”
customers from competitors as the
issuer may have to pay a premium
for each balance. The need to
dangle additional “bait”, possibly a
low “teaser” rate, will have an
impact on the net interest margin,
albeit in the short term.
Targeting of “underdeveloped”
credit consumers might involve
reaching out to high-risk segments
of the market in the quest for growth
— those customers with a low
income or high debt, the elderly, or
those with a problem credit history.
Obviously, the increase in risk
means that high quality riskadjusted

GROWTH IN THE UK

In 1990, total credit card debt
outstanding was almost £9bn and by
1996 this had grown to about
£16bn. In 1990 there were some 80
card issuers and by 1996, this had
grown to more than 800, a ten-fold
increase. This growth partly reflects
the overall growth in consumer
credit in recent years — in
December 1992 annual growth of
consumer credit was 1 per cent and
by June 1997 was more than 18 per
cent. However, Chart 3 shows that
since 1990 the growth in credit
cards has generally been faster than
that of other forms of consumer
credit. At present, credit cards
account for about 21 per cent of net
lending of consumer credit in the
UK (up from 19 per cent in 1991).
The strong growth in the UK
credit card market is all the more
significant because a number of
commentators had believed the
market had reached maturity five or
10 years ago — this belief was
influenced by the fact that the
payment card market in the UK is
one of the most developed in
Europe. However, a comparison
with the US credit card market
shows that the UK has some way to
go to reach the maturity of the US
market. In 1994 there were twice as
many cards per head in the US
as in the UK and borrowing on
credit cards accounts for a larger
proportion of unsecured consumer
borrowing in the US than in the UK

HOW CREDIT CARDS WORK

The credit card market consists of
two very different businesses: card
issuance — the “consumer end”,
which provides credit cards and
bears the credit risk of the customer
and merchant acquiring, and the
“backroom business”, which “signs
up” outlets to accept credit cards
and carries out processing.

The two businesses are distinct,
and in the UK only a few firms are
active in both. Box 1 shows the
interaction between these two businesses.
If the card issuer is a
member of an international payments
system, such as MasterCard or VISA,
an additional “link” is involved
between the merchant acquirer and
the card issuer.1
This article concentrates on the
card issuance business — the area
of greatest change. This business
earns income from both interest
and non-interest sources, although
interest income is usually the main
source.

THE UK CREDIT CARD MARKET

The credit card market in the UK has attracted interest over recent
months, partly because of the strong growth it has enjoyed and also
because of the aggressive behaviour of a number of new entrants. This
article looks at the market and compares some of its characteristics with
those of the credit card market in the United States.

The credit card market is unusual,
so any analysis requires an understanding
of the mechanics behind
the product and the market. The first
part of this article outlines some of
the key sources of income and costs
faced by card issuers and how these
influence the net interest margin of
the product. The next section
considers the recent growth in the
UK card market. Observers have
commented on the similarity between
the UK market now and the US
market 10 years ago, so this section
also concentrates on some recent
developments in the US market.
Then some of the similarities and
differences between the UK and US
card markets are examined, which
may indicate whether the UK will
follow the US trend and issues that
may arise if it does so.

Generational differences and length of time in the UK

Conflicts between older and younger generations were noted,
particularly in Indian communities which had migrated to the
UK in the ‘60s and ‘70s. The older generation had a strong
connection to their homeland whereas their children viewed
their home as the UK2. Recently arrived migrants relied heavily
on their cultural communities to help them establish a place to
live, find employment, provide initial financial support and act
as a conduit with formal institutions. Historical evidence from
Cape Verde indicates that second generation migrants send
less money home than first generation migrants3. Lowell’s
analysis of US-Latin American corridors found that migrants
remit less as time spent in the United States increases4.

Checklist for positive regulatory frameworks for payments in developing countries

A checklist10 to promote a positive regulatory framework for
payments in developing countries is detailed below:
Legal and regulatory issues – are there well functioning
regulatory bodies that administer all participants in the
market? Are legal rights enforceable?
Clarity of regulation – to what extent are there clearly
defined regulations/guidelines regarding acceptable
identification, threshold levels and customer rights? Do
the regulations explicitly address money laundering and
terrorist financing?
Exchange rate regime – what exchange rate regime
does the country operate? How much freedom do
companies have to price the exchange rate to
customers? Are people allowed to receive and hold
foreign currency?
Reputational risk – how does the country measure up
against the international standards over money
laundering, as laid down and assessed by the FATF, IMF
etc11? Are there reputational risks for international
companies participating in this market (e.g. regarding
corruption in country)?
Importance of remittances – how important are
remittances seen in the context of the national economy
from the perspective of the Central Bank?
Barriers in sending countries – what restrictions can
prevent migrants from sending money back? Are
remittance recipients taxed on the income they receive?
Lack of a “productive” use of remittances – what
incentives are in place to leverage remittances into the
formal economy rather than the cash-based economy?
How is saving and investing encouraged rather than
consumption?
A checklist to assess the level of development of the market
is detailed below:
Technology and infrastructure – is there a well
functioning and efficient payments system in place? Is
there the technology infrastructure to encourage product
innovation and access to non-branch networks?

FSA regulation of MSB Activity

Firms authorised by the FSA for their regulated activities,
such as accepting deposits, may also offer MSB services.
Retail and wholesale banks for example, often provide money
remittance services, and at least 40 firms are known to offer
bureau de change facilities.

The FSA’s expectation of all firms is that they should
manage their risks effectively and comply with relevant legal
requirements. In all aspects of its regulation the FSA
stresses the importance of a risk-based approach, that firms
should focus more efforts on the higher risks and less on the
smaller ones. This risk-based approach is crucial in the
money laundering (ML) and terrorist financing (TF) context.
The FSA looks to a firm to have systems and controls that
(a) enable it to identify, assess, monitor and manage ML/TF
risk; and (b) are comprehensive and proportionate to the
nature, scale and complexity of that firm’s activities. It follows
from this that firms should have in place risk-sensitive and
effective ID check arrangements; and that they should
deploy ID alongside other ML/TF tools in order effectively to
manage their risks. Firms are under no obligation to use the
types of approach recommended in the JMLSG Guidance
Notes, but if they choose to do so the FSA would take this
guidance into account in the event of considering any
potential regulatory breach.
The FSA has acknowledged that there can be a ‘fear factor’
with respect to their supervisory approach and enforcement
actions, some firms take a very conservative approach to ID
in order to reduce the likelihood of regulatory sanctions. The
FSA is concerned that any such fear detracts from the
effectiveness of the ML/TF regime and may impact adversely
on consumers. With this in mind Philip Robinson, the FSA's
Financial Crime Sector Leader, wrote to Ian Mullen,
Chairman of the JMLSG in October 2004 to put on the
record the FSA's approach to supervision and enforcement
over ML/TF risks. The letter underlined that only when there
is significant failure in systems and controls does the FSA
consider taking public enforcement action. The letter also
signalled that the FSA would in future focus more on other
aspects of the fight against ML/TF, and is more likely to take
action over ID only if there are particularly aggravating
circumstances such as actual money laundering having
been facilitated by poor practices in the firm.