The third hypothesis is that high interest rates stem from credit card banks having pricing power given their retail-oriented business. Our findings support this hypothesis and suggest that credit card banks incur large costs to attain this pricing power.

We find that credit card operations have exceptionally high operating expenses—4-5 percent of dollar balances annually. These costs account for about half of default-adjusted APR spreads (interest rate spreads minus net charge-off rates).

Concluding Remarks

Credit card interest rates are significantly higher than those of other major loan or bond products. While high default losses contribute, they do not fully explain the magnitude of card interest rates. Our findings suggest that the high rates reflect compensation for default risk that cannot be diversified away, either within the credit card market or across other lending markets in downturns. Additionally, our results indicate that credit card banks have significant pricing power, which they achieve by incurring large operating expenses.