The pandemic didn’t end card rewards. It made them stronger.

When the Covid-19 pandemic halted travel—and travel spending—some speculated that it might also ground credit cards. Card companies had for years leaned on travel-related rewards and point systems to attract wealthier customers and bigger spenders. These often work by awarding points for every dollar spent, which can be redeemed for goods or services from banks’ reward-cards partners, such as airlines or hotel chains. Some even just award a couple percentage points in cash back. But as Americans began concentrating their spending on everyday purchases closer to home, a lot of volume shifted to debit cards.

So credit-card companies scrambled, doing things like offering larger sign-up bonuses or cards with no annual fees. Some also updated rewards and other perks to match changing lifestyles, adding benefits for spending on things like groceries, food delivery and streaming-media services. American Express, for example, added some benefits that might entice people working from home more, such as a credit for purchasing a SoulCycle fitness bike.

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It all worked—maybe too well. Six of the biggest card-issuing banks said they spent nearly $68 billion, combined, for rewards and some related costs in 2022, up roughly 43% from 2019. That is about 4 percentage points faster than the growth in U.S. credit-card purchase volume across the Visa and Mastercard networks over the same period. Marketing costs jumped for many card companies as well.

Thus resumed an arms race in rewards and benefits. Back in 2015, rewards expenses among large banks amounted to about 3.5% of purchase volume, according to a research note by staff at the Federal Reserve’s Board of Governors. By 2021, the most recent data analyzed, that was nearing 4.5%.

Of course, banks don’t just give these rewards and get nothing in return. When people spend, banks earn swipe fees from merchants known as interchange. Some rewards cards also charge annual fees. A portion, but by no means all, of these fees are effectively returned to some spenders in the form of rewards. More spending is still a net benefit to the companies—even if it is a smaller one.

Historically rewards have also enticed some consumers to borrow more as well. That is important because the money made from lending via cards made up about 80% of credit-card profitability from 2014 to 2021, according to the Fed staff’s research note.

In a recent study across hundreds of millions of U.S. credit cards, researchers at the National University of Singapore, the International Monetary Fund and the Federal Reserve found evidence that rewards cards can induce cardholders, especially those with relatively low FICO credit scores, to “overborrow” versus classic cards.

“High-FICO cardholders on average earn money with the use of reward cards while low-FICO cardholders on average lose money,” they wrote. Overall, the study found that rewards cards drove a $15 billion annualized “redistribution” from low-score to high-score consumers.

However, there have been some challenges for banks’ card lending. For one, it is likely getting much more expensive for banks to fund card loans, in part because banks might have to pay faster-rising interest rates on deposits. The pandemic, and stimulus checks, also led many cardholders to pay down their balances more quickly than they did in the past, generating less lending growth and interest income for banks. At the same time, inflation in the costs of dining and travel may be leading customers to even more aggressively use and seek out rewards.

So the risk is that if banks are paying out more in rewards, but aren’t getting as much of a boost in lending growth and income, it squeezes their profitability on cards overall—raising the question of whether those rewards were worth it.

Faster loan growth would help justify higher perk and marketing costs. But trends this year aren’t clear yet, especially with a banking crisis as the backdrop. One leading indicator is whether people are trying to spend a lot more. Consumer spending already was rising more slowly in February after a strong start to the year, according to Commerce Department data. But there are positive signals for banks, too: Many lenders were reporting that consumers’ pandemic habit of carrying smaller balances had started to fade coming into this year. Domestic banks’ card loans on a seasonally adjusted basis have continued rising since the start of the year, according to Federal Reserve data.

Rewards and perks may be a pathway to other revenues, too. JPMorgan Chase, for example, has acquired travel-services providers. Some card companies also believe that the surge in marketing and other customer costs during the pandemic can slow, but the benefit of more engaged cardholders and partners who provide rewards will remain. Amex has described a “virtuous cycle” in which its growing premium customer spending base attracts more promotional partners, which draws in more customers, and so on.

Washington could play a big role at some point, via proposed legislation aimed at enabling more competition among card networks with the intention of lowering swipe fees on credit cards. That might effectively make it more costly for banks to give rewards to spenders. Banks, in turn, could then have one less way to entice people to spend—and, ultimately, borrow—more. Card perks, after all, are not their own reward.

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