Why Do Banks Offer 0% Balance Transfers?

Written by David Long on August 11, 2010 – 4:49 pm

20 years ago, credit cards with “no annual fee” and “0% intro APR” were rare. Then, Providian entered the fray. The company was first to pioneer the practice of offering credit cards with attractive sounding terms, but with heavy penalty fees in the event of a mistake. This allowed them to offer the best sounding deals out there, and attract a previously unbanked population of lower income households.

Consumers responded unwittingly, not realizing that $39 late payment fees, punitive rate hikes in the event of a late payment, and huge overlimit fees would (on average) fund the cost of providing things like “no annual fee” and “0% intro balance transfer“, along with other perks. Competitors were soon forced to followed suit, and the concepts of “free” and “0%” went from an innovation to an industry standard. The poor ended up subsidizing the rich, because punitive fees from those who were missing credit card payments were allowing card issuers to offer better teaser deals to those who were paying on time.

Balance Transfer Offers Are Changing Rapidly As Banks Prepare for CARD Act Phase 3

Bank activity around balance transfer deals has been frenetic over the past year, due primarily to the CARD Act. As phase 3 of the CARD Act goes into effect August 22, 2010, some banks are abandoning balance transfers in a big way, while others are moving in to fill the gap.

Who Is Bailing? Credit Card Focused Institutions

The three big card issuers that derive most of their income from credit cards have all drastically reduced their 0% introductory balance transfer offerings in the past year. Just last month, Capital One offered 0% balance transfers on most of their cards. Now only two of their cards offer this deal. Similar cutbacks happened at American Express and Discover last year.

“A year ago, we responded to the CARD Act by making a number of significant changes to maintain profitability including dramatic decreases in balance transfers. These changes are largely complete, so we expect card receivables to start showing modest sequential growth over the next several quarters.” – David Nelms, CEO, Discover

Who Is Stepping In? Banks With Huge Balance Sheets

Many banks that traditionally have the best balance transfer offers have raised their balance transfer fees from 3% to 4%, or even 5% in the past 6 months. These include Bank of America and Citi.

Banks with big balance sheets are facing a huge problem – lack of loan demand due to the recession. The reason this is a problem for them is because their lifeblood is lending your deposits out at a higher interest rate, whether it be for a mortgage or a credit card line of credit.

To give you an example, Citibank is so eager for balance transfers that they are offering 0% APR for 18 months on the Platinum Select card. Quite an odd phenomenon as their competitors run from the market! But keep in mind that Citi has $827 billion in deposits that it has to loan out to someone, and loan demand is scarce.

So Should I Take Advantage of An Intro APR Offer?

Banks depend on your optimism to make money on balance transfer teaser offeres. While Citi won’t raise your intro APR for missed payments, they will charge you fees on the order of $39 for late payment.

Most people don’t apply for financial products with the expectation that they will face an unexpected financial setback. However, on average, enough people will trip up to result in a tidy profit for the issuer. Studies into behavioral finance, like this one from David Laibson at Harvard, explore why every human brain is a sucker for irrational financial decision making. So before you convince yourself that you won’t become the next victim of spiraling credit card debt, realize that smart mathematicians at Citi know that statistically speaking, you will.

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