As Congress prepares to consider legislation capping credit card interest rates next week, banks said yesterday that the measure would worsen the "credit crunch" by eliminating a key technique they use to boost their balance sheets.
The Senate probably will vote next week on overall bank reform legislation, which includes an amendment capping the interest that banks and department stores can charge. A House subcommittee is to take up credit card legislation Monday and, although it does not include a rate cap, there is sentiment among members to amend the bill to include one.
But banks said this week's response to the proposal on Wall Street, where securities backed by credit card accounts dropped dramatically in value, was the most telling indication of the consequences of a rate ceiling.
The cap, proposed by Sen. Alfonse D'Amato, R-N.Y., and approved in the Senate by a wide margin, would effectively reduce credit card vates to about 14 percent. Interest on many cards now hovers around 20 percent.
The lower interest rate, banks said, probably would preclude them from selling the credit card-backed securities, a practice that dates only to the mid-1980s.
Banks pool their credit card accounts and sell them as securities to institutional investors such as trust funds, insurance companies and mutual funds. The securities are highly rated, and banks pay investors a healthy return, currently 8 percent to 9 percent.
The reason banks don't want these credit card balances on their books is that regulators require them to have capital, a cushion against losses, to back up all loans. Selling the credit card accounts, which are essentially consumer loans, means they don't have to maintain capital to offset them.
Banks said that if the cap were imposed, it would not be worth selling the securities. That's because the total cost to the bank -- the interest paid to investors plus administrative costs and losses from card holders who do not pay their debts -- would outstrip the interest consumers would pay.
In the end, the banks said, they would have to keep the credit card loans on their books and raise more capital to satisfy regulators, mean- ing they would have less money to lend.