Claire Célérier holds the Canada Research Chair in household finance and is an associate professor of finance at the University of Toronto’s Rotman School of Management.
Today, more companies are pushing the limits of consumer credit, promising new opportunities for increased consumption. In doing so, they are targeting increasingly vulnerable groups. This is a cause for concern, particularly as traditional Canadian banks begin bringing these so-called innovations to their customers.
A striking example is the recent partnership between Bank of Nova Scotia and the fintech Casa. Their pitch is to make rent payments more rewarding by offering a zero-fee credit card that allows people to earn points by paying their rent. At first glance, it seems very attractive. One may even wonder why such a scheme hasn’t already caught on.
Let’s take a step back and consider the business model. Receiving credit-card payments is costly: It implies paying interchange fees to banks, up to 2 per cent of the transaction amount, which explains why landlords would naturally be reluctant to accept rent payments this way. However, Casa promises zero costs to landlords. How? Casa receives the credit-card payments and pays the interchange fee, while transferring the money to landlords at no charge. A puzzle arises: How can Casa be profitable? This is where the partnership with Scotiabank comes in.
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One recurrent pattern in retail finance is the propensity to conceal risks while exploiting behavioural biases. In this case, credit-card users, who must handle recurring large payments for rent, will also run the dual risk of high interest rates on large unpaid balances and penalties for late payments. On average, customers pay a 20-per-cent interest rate on unpaid credit-card balances, while late-payment fees are in the range of $25 to $35. This naturally benefits Scotiabank, which in turn compensates Casa for bringing these new profit-generating clients and operations. If this compensation more than offsets the interchange fees, the puzzle is solved.
As often in consumer finance, the business model preys on both a preference for immediate gratification and overconsumption and the fear of not meeting one’s rent, to the detriment of long-term financial health. And this is a profitable strategy: Margins in consumer credit are much larger than in mortgage credit.
While consumer credit claims to increase opportunities for the less advantaged, in reality it contributes to the financial gap we observe in Canada between generations, renters and owners, rich and poor. While the levels of consumer debt and delinquency seem relatively stable, this stability masks a growing disparity: Today, the young face historically high levels of delinquency on their credit cards, up to 2.35 per cent for those younger than 36, according to Equifax.
Of course, one may argue that savvy renters will benefit from the plan by collecting rewards. That may be true, but in fact, it further widens this financial gap. These reward plans are effectively subsidized by those who have less: First, through the high interest rates and penalties they are likely to pay in case of late payments; and second, through higher retail prices.
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While we are all aware of the rising cost of living, most of us don’t realize that increasingly expensive rewards play a part in it. Credit-card reward programs are largely funded by the interchange fees merchants pay each time they accept credit-card payments. And increased rewards mean higher fees. The gap is significant: Today, when a client pays using a premium credit card, the interchange fee, at around 1.8 per cent to 1.9 per cent, is up to twice what it would be with a core credit card. Since most merchants are in no position to refuse any credit card, core or premium, they typically pass these costs on to consumers by increasing prices, no matter what payment method is used. Conclusion: All consumers pay higher prices, and the poorer subsidize the rewards enjoyed by the more privileged.
Over all, these recent innovations in consumer credit – new credit card and leasing products, “buy now, pay later” plans – all have one common claim: They promise new opportunities to a population that feels increasingly hopeless, as entry-level jobs become scarcer, housing is less affordable and the cost of living grows. But it is hard to believe that financial leverage is the solution. This may rather be a ticking time bomb that is compounding the affordability crisis with a risk of insolvency. Given the usually high standards of the traditional Canadian banks, it is surprising to see Scotiabank undermining this legacy by entering the field.