Why putting in stricter credit standards is making credit card debt riskier for banks

09/14/2009 6:20 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

You know why I can't settle in to a comfortable optimism about the stock market?

Because the financial system is so complicated that just when the best and the brightest think they've got it all figured out, reality bites them hard.

Here's an example. We all know, some of us from personal experience, that banks have found the true religion now when it comes to credit card lending. They're busy cutting credit limits, raising credit standards, tightening payment deadlines.

All the stuff they should have done before the financial system's near collapse.

That's had the effect of cutting the amount of consumer debt. Add in the efforts to consumers to pay off their balances and it's no wonder that the amount of credit card debt has fallen every month since February. (And if you don't think that's a big deal, the February drop was the first in the 40 years that the Federal Reserve has tracked this data.)

But, perversely, while the total amount of credit card debt is falling, the proportion of card holders who have fallen into the most risky subprime category has climbed as a percentage of the whole. These accounts have been dinged by falling credit scores, rising balances, and increasing numbers of late payments.

It's not hard to figure out why. The folks who can pay down debt are paying down debt. That's why the total is falling. But those folks who don't have the money (Ya think maybe because they don't have jobs?) to reduce their balances, and are indeed so stressed that they're now in danger of falling into deliquency on their accounts.

Which is quite a problem for the banks. They've got less debt from their best customers--the folks who can afford to pay and who are less of a risk--and they've got more debt from their worst customers--the folks who can't afford to pay. 

That can't be good for the bottom line. Tune in next quarter to see what that does to bank reserves for loan losses.

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