By Manya Saini

Jan 12 (Reuters) – A proposed one-year cap on credit card interest rates backed by U.S. President Donald Trump could reduce borrowing costs for some consumers but also limit credit availability, pressure bank profits and reshape the economics of consumer lending.

Trump called for the cap on Friday, without detailing how the plan would be implemented, while Wall Street analysts said such a move would require legislation and has slim odds of getting clearance.

Financial stocks from Wall Street to Canary Wharf fell on the news on Monday.

WHY IS CREDIT CARD DEBT SO COSTLY FOR BORROWERS?

Credit card debt, with rates currently averaging 19.65%, according to consumer financial services company Bankrate, compounds quickly, particularly when borrowers make only minimum payments rather than paying off balances in full.

This form of borrowing, known as revolving credit, can keep consumers in debt for years as interest costs accumulate and balances decline slowly.

Subprime borrowers, or those in lower-income brackets with weaker credit histories, are particularly vulnerable to falling into an adverse credit cycle as high interest rates, fees and minimum payments slow progress in reducing debt.

U.S. credit card balances rose to $1.23 trillion at the end of the third quarter ended September 30, according to a report from the Federal Reserve.

Some consumers carrying existing balances could see short-term relief from lower interest charges.

COULD A CREDIT CARD RATE CAP AFFECT U.S. CONSUMPTION AND ECONOMIC GROWTH?

A pullback in credit card lending, as a result of a rate cap, would weigh on consumer spending, a key driver of the U.S. economy, even as lower interest burdens offer some relief to households stuck in a revolving credit cycle.

“Consumers would be restricted by card companies, leading to weaker retail sales and consumption across the entire economy, hurting GDP (Gross domestic product),” analysts at Jefferies wrote in a note.

Banks may pull back on credit card lending to protect margins, because a rate cap limits how much they can charge borrowers who miss payments. They rely on the extra interest income to offset losses when some cardholders default, making it harder to lend profitably to riskier customers.

“We estimate it would swing the business to unprofitable if enacted, with subprime credit cards hardest hit,” Truist Securities wrote in a note.

In a joint statement, banking industry bodies said the move will hurt “millions of American families and small business owners.”

HOW WILL BANKS AND CONSUMER LENDERS BE IMPACTED?

For banks and consumer lenders, an interest-rate cap would cut into one of their most profitable lending businesses. Credit card interest rates can climb as high as 30%, compared with an average rate just above 6% on a 30-year fixed mortgage, according to Bankrate.

A rate cap could wipe out billions of dollars in interest income for banks and card issuers, analysts say, forcing lenders to rethink the scale and pricing of their card businesses.

“If this were to be enacted, there will be material headwinds to card profitability and likely result in card issuers tightening credit boxes meaningfully, particularly to high-risk borrowers,” analysts at Barclays said.

WHO COULD BENEFIT FROM A CAP ON CREDIT CARD INTEREST RATES?

A tightening of credit in a heavily regulated banking sector could push some consumers, particularly subprime borrowers, toward buy-now, pay-later providers, pawn shops and even loan sharks.

“This rate cap would not address the root of the problem and could push consumers towards more expensive debt if the cap does not apply to other unsecured consumer products,” J.P. Morgan analysts said.

“It could push more borrowing away from banks into other unsecured loans such as pawn shops and other non-bank consumer lenders.”

Borrowing from the less regulated parts of the credit market would increase risks for consumers already under financial strain.

Buy-now, pay-later services, which typically earn money from merchants rather than charging interest to consumers, have surged in popularity in recent years, particularly among younger borrowers, and could benefit if banks rein in credit card lending.

(Reporting by Manya Saini in Bengaluru; Editing by Shinjini Ganguli)

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