Interest-free credit cards a ‘ticking time bomb’, bankers fear

Bankers are sounding the alarm over interest-free credit cards, warning they are a “ticking time bomb” that could lead to the kind of revenue scandal that hit supermarket Tesco.

A number of Irish lenders offer introductory 0 per cent balances, including Bank of Ireland, KBC Bank, Permanent TSB and Tesco.

Lenders that offer zero per cent balance transfer cards book upfront some of the revenue that they expect to gain once a customer ends the interest-free period and starts paying a high rate.

But several bank chief executives and analysts have told the Financial Times that the practice is extremely risky as it is based on the assumption that customers will still have the debt on the card when the deal ends and start to pay a high interest rate.

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One bank chief executive, who wished to remain unnamed, dubbed it a “ticking time bomb” and compared the situation to the Tesco scandal in 2014 that cost Britain’s biggest grocer at least £214m in fines for overstating profits.

“Lenders are recognising revenue now, but there’s no — or limited — cash flow associated with it and it’s going through the profit and loss accounts,” he said, adding that bankers’ bonuses were being paid on the back of seemingly inflated profits.

With banks offering interest-free deals for up to 43 months — fuelling record levels of British credit card debt that surpassed £67bn this year — it has become even tougher to forecast long-term customer behaviour.

Banks that offer zero per cent balance transfers include Barclaycard, Virgin Money, and Lloyds Banking Group. Virgin Money could be more exposed, analysts argue, as it has seen significant growth in credit cards, which account for nearly 10 per cent of its loan book.

The issue of so-called effective interest rate (EIR) accounting is compounded by recent proposals from the UK watchdog for banks to protect credit card customers in persistent debt by waiving charges and interest in some cases. This would hit lenders that have already accounted for the expected future revenue.

Analysts at KBW said in a recent note that Virgin Money could lose about 18 per cent of earnings this year if it were to move to cash accounting as a result of concerns. Other banks offering credit cards were also likely to be hit.

One banker told the FT that if data on customers who took out a balance transfer card showed only some moved to high interest rates — when the lender had assumed a bigger percentage would shift — the bank would have to correct the accounting for all customers in an “enormous hit to P&L”.

Although lenders have to use EIR accounting as part of global accounting standards, he warned some bankers were applying it in a much riskier way.

Steve Pateman, chief executive of Shawbrook, a challenger bank that does not offer these cards, said: “The danger with EIR is that you are booking revenues based on something that you believe will happen and there is an inherent risk that your assumptions don’t pan out that way.”

He added that there was a “lack of logic to booking revenues on an assumed income flow but not the assumed loss”.

The Bank of England’s Prudential Regulation Authority recently launched a review of banks’ consumer credit quality, but it was unclear whether it included an assessment of this accounting methodology.

Andrew Hagger, of consumer site Moneycomms, said the zero per cent balance transfer market was “huge” with statistics for March showing 609,000 transactions totalling £1.34bn in a single month.

Jayne-Anne Gadhia, chief executive of Virgin Money, said: “We are very confident of our assumptions, which are, of course, explicitly and fully audited every half year and full year.”

George Culmer, chief financial officer of Lloyds, said the bank applied its accounting methodology more “prudently” than some rivals.

Ian Gordon, an analyst at Investec, recently told the FT: “When you have a zero per cent credit card your earnings are not zero — you have cash transfer fees, income from card usage.

“EIR calculation is something all banks are required to do, so that they are in effect recognising customer behaviour.”

Copyright The Financial Times Limited 2017.