Have you ever received a free flight as a result of your Delta SkyMiles card? Or maybe your Capital One Venture Rewards Card gives you the benefit of going through the fast TSA PreCheck queue at the airport instead of having to wait in the usually very long general security line.
About 90% of all credit card spend is on rewards cards. If you play the game right and maximize your rewards, you could save at least a few hundred dollars every year.
“We’ve created an ecosystem where we’re essentially giving the consumer a drug, which is these reward cards,” said Sumit Agarwal, finance professor at the National University of Singapore. “And the reason we continue to give this drug is because we know it’s extremely profitable and the consumer depends on it.”
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In 2019, the largest US banks paid out nearly $35 billion in rewards in return for all spending on these types of credit cards. But where does this money come from?
In the same year, banks reported sales of more than $140 billion from all credit cards. This comes from three main revenue streams: $9.9 billion in fee income, $89.7 billion in interest income, and $41.3 billion in interchange or swipe fees. More than half of that revenue comes from reward credit cards, according to Agarwal.
Agarwal et al exacerbates existing inequalities. That means $15 billion could be redistributed to achieve more equality.
“Low FICO [credit score] Customers are essentially spending so much more on these rewards cards to get access to the rewards, which is only 2% or 3% of the total value of the spend, that they are piling up debt, and that debt piling up…causing this huge interest payment that goes on the bank,” Agarwal said.
“It also goes to the high FICO customers, because those high FICO customers are just taking advantage of those rewards, they aren’t accumulating debt,” Agarwal said.
“So they get cross-subsidies on using their reward cards,” he added.
But Andy Navarrete, executive vice president and head of external affairs at Capital One, said there is no cross-subsidization and the bank’s rewards cards are designed to be independently profitable.
We’ve created an ecosystem where we’re essentially giving the consumer a medicine.
Sumit Agarwal
Finance Professor at the National University of Singapore
“While there are certainly customers who borrow with their credit cards, these aren’t typically the revenue streams that fund award cards,” Navarrete said.
“The flawed premise behind this study was that those who have balances and therefore pay interest are actually cross-subsidizing or, as you know, contributing to the overall profitability of rewards programs,” Navarrete added.
“That’s actually not the case,” he said.
Regard the video above to learn more.