September 2022

Rising Inflation and the Credit Card Industry

The U.S. economy has been on thin ice lately. Just last month, inflation reached a 40-year high, with the average price of consumer goods rising by roughly 9%, before cooling down ever so slightly to a still-bloated 8.5% in July. 

In the meantime, bringing prices back down has become the top priority of the U.S. Federal Reserve, which responded to the latest sky-high inflation reading by hiking interest rates by a whopping 75 basis points (0.75%)—the largest increase in almost 30 years. By continuing to raise interest rates each month for the indefinite future, the Fed's hope is that American consumers will be incentivized to save more and spend less, and that a subsequent decrease in demand will gradually cause the price of goods to fall. 

For now, we don’t know if the Fed’s strategy will ultimately be effective, and whatever happens in the future doesn’t change the present. Both businesses and consumers are feeling the sting of inflation, and how they move forward will impact both the broader U.S. economy and, you guessed it, the credit card industry. 

In this blog, we'll take a closer look at the existing and potential impacts of high inflation on the credit sector, from the influence of rising interest rates on the market, to the increasing utilization of digital credit products and payment solutions. 

As the Fed hikes interest rates, lenders follow suit

While hiking interest rates to tame inflation is not out of the ordinary, and is generally thought to be a reasonably effective approach, it also comes with consequences. In the end, the Fed may be successful in bringing inflation under control, but they also may need to inflict some additional damage in the process. 

One immediate impact of the Fed’s ongoing rate hikes has been a subsequent rise in interest, or annual percentage rates (APRs), for credit card users. The higher the Fed moves the “benchmark” rate, the higher credit card companies raise APRs.  If popular estimates come to fruition, APRs could climb to as high as 19% by the end of 2022, which would represent the highest average interest rate on record. 

Basically, borrowing money is becoming increasingly expensive, and unfortunately, this may be happening at a time when many consumers and small businesses need credit lines the most. As this trend continues, however, it could be the perfect opportunity for alternative providers in the lending and digital payments space to demonstrate their unique value. 

Innovation to the rescue

As we’ve touched on in previous blogs, consumer preferences for innovative, easy-to-use payment and credit solutions like digital wallets and buy now, pay later (BNPL) services have increased since the onset of COVID-19. Now, as rising inflation threatens both the business models and borrowing power of small businesses and startups, the traditional commercial credit industry seems to be accelerating its own transition into the digital payments space. 

In addition to increased demand among consumers, there are at least two compelling reasons for merchants and financial institutions to seek alternative lending and payments solutions in response to high inflation: preservation of revenue streams to offset tightening financial conditions and increased access to capital. 

While consumers are feeling the pinch of higher prices, merchants are feeling the subsequent pain of declining revenues and margins. And while business owners may have little power when it comes to easing headline inflation, they recognize that they can preserve margins by offering more flexible, less expensive payment options. 

According to a recent study by PYMNTS and ACI worldwide, 94% of executives today believe that digital billing capabilities will be essential for growth. Even still, as principal solution consultant at ACI Tom Donovan, pointed out to PYMNTS in an interview, more executives are bound to integrate digital solutions as they begin to understand the potential benefits of enabling new payment channels, specifically the ability to increase transactions and overall sales. 

For some small businesses, however, a slight boost in revenue won’t provide them the kind of access to capital necessary to stay afloat in an economic downturn. This is another reason why many experts in the space believe the commercial credit landscape is overdue for a much more comprehensive digital transformation. Traditional lending and issuance processes make it hard for new businesses to access capital, particularly in an inflationary environment. 

Most legacy issuers lack the data-processing capabilities of emergent fintechs, and these tools can be leveraged to make significantly more informed decisions about the viability of a business seeking a loan. As a result, an increasing number of banks have been partnering with innovators in the digital payments and embedded finance space to integrate a wealth of new data into the issuance process, ultimately making loans more accessible to businesses in need. 

Again, these are only two use cases of modern, digital-first credit solutions that seem to be directly correlated to rising inflation. But when we take other factors into account such as consumer preferences increasingly favoring virtual cards and contactless payment methods, or the ongoing digitalization of cross-border payments infrastructure,  inflation might be accelerating an existing and inevitable evolution of the credit industry. 

Taking the bad with the good

The trajectory of inflation remains largely unclear. The unfortunate truth is that the macroeconomic factors contributing to the ongoing downturn are various and, for the most part, out of any single individual or organization’s control. 

That said, as troubling as the current state of the economy seems, a number of recent developments in the credit sector indicate that rising inflation might serve as another catalyst to further adoption and innovation in digital credit card and payments technology. Between increasing the capacity for businesses to earn revenue and institutions leveraging data to improve the fairness and efficiency of the lending process, the credit sector will not only survive inflation but also emerge with an entirely renewed identity, one that truly reflects the needs and expectations of our modern world.

Recent posts