Proliferation of credit cards in Canada, 1984-2014

The six major Canadian chartered banks and other financial institutions are well aware of Canadians’ extensive use of VISA and MasterCard (MC) credit cards. According to the latest statistics published by the Canadian Bankers Association, not only the number of these cards in circulation has mushroomed from 13 million in 1984 to 72 million by 2014, the number of issuers of these cards has also jumped from 10 to 28. In 2014, there were 15 principal issuers of MCs and 13 of VISA cards.

Subsequently, the number of merchant outlets, accepting VISA and/or MC has increased 3.4 times – from 442,928 in 1984 to 1,485,147 in 2014. And, the gross sales slips issued by these merchants have sky-rocketed from 325.2 million to 3,675.6 million – an increase of 11.3 times compared to an increase of 1.5 times in the potential number of credit card users, i.e., the population 18+ (18.9 million to 28.6 million). This translates into 128 gross sales slips processed per person in 2014 compared to 17 in 1984 (Chart 1).

Chart 1_credit card_blog

The net dollar value of transactions on these cards (including cash advances) has risen from $17.10 billion in 1984 to $399.23 billion by 2014 – a 23-fold increase. Since money owed on credit cards is a part of consumer debt, no wonder, Canadians are increasing their overall consumer debt, as reported periodically, by both Statistics Canada and the Bank of Canada. Canadians seem to be in love with their credit cards. They likely use these not only to purchase goods and services, but also for convenient travel, bill payments, shopping on phone, and above all, for shopping online. The continuing growth of e-commerce is one of the key factors pushing the use of credit cards.

Sensible use of credit cards
It’s not bad to use credit cards (as a convenient and handy source of payment for any purchase in-person, or online) as long as users can repay their full balances each month. If that were the case, users won’t pay any interest to issuers, who will still make money on commissions charged to merchants selling goods on credit cards. But the reality is different. A good proportion of these card users carry-over monthly balances, likely because they don’t have sufficient funds to fully pay off their accounts, on interest rates as high as 20+%. These balances accumulate over time, putting these users deeper and deeper in the hole. These users constitute the most financially vulnerable group. Of any payment they make, a good portion of it will likely cover the interest charges. And, if they are making just the minimum payment, then almost the entire amount is simply covering the interest charges. Interest paid by these users is all that institutions need to solidify their revenue base. Those who pay off in full each month hardly contribute to this base (other than paying their annual card fee – which, again, varies with the type of card they carry). Since the interest on loans and credit cards is one of the key sources of revenue of issuers, they want to keep this financially vulnerable group as well as their peers around by further offering them various incentives, including the reduced monthly payment, periodic increases in their credit limits, allowing them to skip a payment with full interest charged – to name a few. Because it’s the interest income from this group that’s supporting other customers’ free air travel, variety of insurances, car rentals, ad-hoc rebates, cash-back programs, etc. In other words, this group is helping issuers not only to keep their other customers happy, but also in expanding their businesses.

Card issuers are not to be blamed
To be fair to card issuers, the truth be told. We live in a democratic and free-market system. Issuers are not forcing anyone to use their credit cards. It’s the user and his/her vulnerability, financial needs, impulsive shopping habits, inability to postpone a purchase, or some personal urgency, that may make him/her to use a credit card – that, too, of his/her own choice. Issuers of cards are there in the market, selling ‘money as a good at a cost’ to customers in need of their product. Issuers have to protect their money against any risk as well as earn a decent return by charging interest. On the other hand, users have the responsibility to weigh the pros and cons of using credit cards to finance their spending habits. They need to ensure about their ability to handle credit well, and within their affordability. The onus is strictly on a user to pay in full or carry-over the monthly balance. He/she doesn’t want to be labelled as ‘delinquent’, or ultimately ‘bankrupt’ (I will be writing a separate note on personal bankruptcies).

90-Day delinquency rate
The financial institutions define the fiscal year-end ’90-day delinquency rate’ as the ratio of the number of overdue accounts for 90 days expressed as a percentage of all accounts. So a user who is making just the minimum payment monthly is not a delinquent even though he/she isn’t paying any principal. No wonder, the 90-day delinquency rate has been around 1% or less with the exception of fiscal year 1990, when the rate jumped to its highest value of 1.8% (Chart 2). Keep in mind that the Canadian economy experienced a mild recession over the 1990-91 period. During the recession, those people who lose jobs and have no savings to rely on, usually depend on borrowed money – as a bridging measure. Another spike in delinquency rate of 1.3% can be noted for 2009, year when the economy just began to turn around after the recession – from late 2007 to early 2009. Technically, users who can’t pay a portion of balance outstanding should be treated as delinquent. But since the institutions care only for their interest income, they are not bothered about the time such users will take to repay their balances outstanding. Institutions simply remind users each month the time (in years and months) it will take to repay the balance if they kept paying only the minimum payment.

Chart 2_credit card_blog

What’s this minimum monthly payment?
This payment is the interest charged on the outstanding balance from the previous month plus ten dollars. Even though there are lots of calculators available on the Google site for users to calculate their monthly payment for a given amount outstanding, at a given interest rate, I am simply illustrating a case for the benefit of my readers.

Say, one owes $5,000 at 13.99% interest rate. The interest is charged daily. So the first thing to do is divide 13.99% by 365. This gives us a daily rate of 0.0383%. Now if one’s statement period covers 30 days (as usually shown on the monthly statement), then the monthly interest charged is: (5000×0.0383×30)/100 = $57.45. Add $10 to this, and you have a minimum payment of $67.45. So if one pays this amount only, then it is evident that one is simply paying the interest charge on $5,000, and just about $9 or so to pay off the balance outstanding. At this rate, a user will take closer to 500 months (or 41 years and 7 months) to pay off $5,000. That’s what the card company writes as a reminder on its monthly statement. For $10,000 balance, it will be close to 1,000 months (or 83 years and 3 months). The inclusion of this reminder, along with the rate of interest being charged on the balance outstanding, in a monthly credit card statement is mandatory in Canada. Its objective is to remind and persuade users to pay more than the monthly minimum to pay off the balance quicker.

Simply making the minimum monthly payment will leave the card user in debt forever.

Tags: VISA/MASTERCARD Credit cards Consumer debt

Minimum payment Interest on credit cards

Household debt is rising in Canada

Statistics Canada regularly publishes the ratio of total household debt to disposable income. Since this ratio has been steadily rising, its publication alarms and reminds Canadians the extent to which they are in debt relative to their incomes available for spending and saving. More debt means committing more income to pay-off debt, reducing the potential to save for any contingency including saving for children’s higher education, and eventually, retirement. Not only that, highly indebted Canadians would have limited money left over for paying monthly bills, and other committed expenses, and for day-to-day spending on essentials. This personal spending is one of the key ingredients of economic growth. The bottom line here is that if indebtedness of Canadians continues to grow and they have less and less money left to spend and/or save, it’s eventually going to affect the health of the economy. We may witness a home-grown economic recession resulting in from this steadily growing household debt.

In this note, I comment on the rising indebtedness of Canadians over the last three decades: 1984-94, 1994-2004, and 2004-2014. Besides talking about the two main components of household debt, i.e., mortgage and consumer debt, I show in the accompanying charts the increasing role of consumer debt in household consumption expenditure or spending, which in turn, plays a role in boosting the economy’s health. In other words, consumer debt is not only becoming more and more instrumental in maintaining household spending but also increasing its proportion of nation’s gross domestic product (GDP). This debt induced growth can’t last for ever. Eventually, Canadians are going to be squeezed in their own financial web.

Debt-to-income ratio has been rising
The ratio of total debt outstanding to household disposable income has risen from 57.4% in 1984, to 92.8% in 1994, 115.5% in 2004, and 158.2% in 2014 (Chart 1). This shows that in 1984, we Canadians owed 57 cents of each dollar of disposable income; thirty years later, we are owing one dollar and fifty eight cents – meaning we owe more than our disposable income (since we are using macro data, we are referring to a national picture rather than of specific groups of households owing debt or no debt). Nationally, we have substantially increased our debt liability. Since both the size of the economy and population have increased over time, we measure changes on a per capita or per person basis. For instance, our total debt per person has risen from $6,370 in 1984 to $49,740 by 2014 – an increase of 7.8 times, compared to the 3.1 times increase in our per capita income – from $17,900 to $55,560. This shows that we have been raising our indebtedness at a rate faster than the growth of our national economy (Chart 2).

Chart 1
Chart 2

Mortgage debt is the bigger component of total debt outstanding
Mortgage debt is the bigger component, constituting 68.4% of the total debt in 1984, rising to its maximum share of 74.6% in 1993, then dropping to 68.3% by 2004, and then climbing again since 2010 to 70.5% by 2014 (Chart 3). The highest mortgage share during the early nineties can be attributed to the hectic pace of purchasing and upgrading of houses by the so called ‘baby-boomers born between 1946 and 1965’ who were then aged between the late twenties (likely buying their first homes) and mid forties (likely purchasing up-graded homes). On the other hand, their corresponding cohorts, born between 1965 and 1984, were purchasing homes in 2010 and after with relatively higher mortgages – including the short period when buyers could purchase a house with no down payment at all, or move into a fully mortgaged house. Again, during the early 2000’s, the federal government of the day tinkered with the amortization period, relaxing to 40 years from the conventional 25-year term, which in turn, may have encouraged potential buyers to take higher mortgages. Right now, we are back to the conventional 25-year term.

Chart 3

Also keep in mind the way the concept of mortgage debt is defined here. This includes not only the amounts taken to buy the first house, but also any subsequent upgraded house(s), house purchased for investment purpose to generate rental income, loans taken as reverse mortgages to pay off consolidated debts, or to finance children’s higher education, or have funds for a new or on-going business. Here, the home equity (i.e., the market value of home less its mortgage debt outstanding) plays a crucial role of a secured collateral that can be used to borrow funds to meet any contingency.

Use of consumer debt is growing
Consumer debt, on the other hand, represents all debt outstanding on different credit cards issued by banks, department stores, other retailers and institutions, student loans, car loans, secured and unsecured lines of credit, and all other outstanding loans and unpaid bills. This debt is open to use to purchase all kinds of goods and services ranging from travel, entertainment, household goods and appliances, to paying bills, and for some really financially straitened, for putting food on the table. Its share of total debt had remained around 30% with the exception of 1993 when its share dropped to its lowest at 25.4%. However, looking at this debt outside its share of total debt, it is worth noting that consumer debt per person has risen from $2,012 in 1984 to 14,662 by 2014 – an increase of 7.3 times compared to the eight-fold increase in the mortgage debt (Chart 4). This increase in consumer debt between 1984 and 2014 can be attributed two factors: first, the growth (3.2 fold) in households’ consumption expenditure exceeding the growth (2.8 times) in its disposable income, and second, the heavier overall indebtedness pushed by factors like different incentives offered by credit cards, pitches of car loans with no down payment, and accessibility of lines of credit at low interest rates. For a household with expenditure exceeding income, and no liquid saving available, there is hardly a choice other than to use credit to purchase the desired goods and services.

Chart 4

Consumer debt represented 21.4% of total household consumption expenditure in 1984, rising to 26.1% by 1994, 37.4% by 2004, and 48.6% by 2014 (Chart 5). Put another way, consumer debt was one-fifth of total consumption expenditure of households in 1984; thirty years later, it’s nearly one-half. If this debt is cushioning up household spending, and this spending being a key component of our national economy, then evidently this debt is equally helping the economy float and grow. Consumer debt, which represented 11.2% of our nation’s gross domestic product (GDP) in 1984 jumped to 26.4% by 2014 (Chart 6). Even though the household spending as a proportion of GDP hasn’t changed much over the last thirty years (just hovered between 53% and 56%), the importance of consumer debt to the growth of the economy has been growing.

Chart 5
Chart 6

Most of the changes occurred between 2004 and 2014
Most of the changes in the key financial components of households occurred over the 2004-2014 decade.For example, of the total increase of $1.5 trillion in GDP (in current market prices) between 1984 and 2014, 21.6% was over the 1984-94 decade, 35.5% over 1994-2004, and 42.9% between 2004 and 2014 (Chart 7). On the other hand, of the total increase of $1.6 trillion in total debt, 58.2% alone occurred over the 2004-2014 period. This is the period when the real estate market went through dramatic changes including a sudden surge in prices of homes across the land, pushing demand for larger sums of mortgages, tinkering with rules on down payment, mortgage amortization term, uncertain economy, low interest rates, role of foreign buyers and speculators, and stagnant incomes. As a result, the likelihood of owning a home, a cherished dream of each and every Canadian family, seems to be slipping away for certain demographic groups.

Chart 7

Parting words
The growth in debt isn’t going to stop. Keep in mind that not all debt is bad. Any debt taken to improve income potential or to acquire an asset is considered as a good debt. Canadians, including potential immigrants, aspiring to own a home, are going to take hefty mortgages to purchase a home. Similarly with tuition and other costs of obtaining higher education rising, persons aspiring to acquire higher education or upgrade skills are going to take more student loans. With incomes stagnant, rising expenditures are equally going to make households borrow more to finance their needs. Middle income families are no longer the exclusive users of consumer credit. Affluent families use it too for convenience, or to reap benefits and rewards (like air travel including insurance) offered by credit cards. Canadians have to use some degree of self-discipline to use credit wisely and within their financially comfortable boundaries. That’s one way to slow down the growth of household debt.

(See my next blog on the concept of minimum payment and the small-print statement, though legally required, on the number of years it will take to pay off the balance – something we see in our monthly credit card statement).