Fed study sounds alarm over algorithmic rises in credit limits

The widespread practice of banks increasing credit card limits poses potential harm to consumers and raises questions for policy-makers, argue researchers with the Federal Reserve Board.

Their paper, published on January 16, says credit cards are underpinned by “an increasingly complex algorithmic infrastructure”, which determines who receives more credit and when. Credit card issuers deploy sophisticated algorithms that continuously analyse users’ spending and borrowing behaviour, and often increase credit limits without consumers requesting such changes.

The authors – Vitaly Bord, Agnes Kovacs and Patrick Moran – say that under US regulations, lenders have “nearly unfettered ability to raise credit limits”. They contrast this with countries such as Canada, which requires consumer consent for limit increases, and the UK, which prohibits limit increases for borrowers with persistent revolving debt. 

Using data on around 70% of the US credit market, the authors find that around 12% of credit cards receive limit increases annually. Of those increases, 80% are initiated by the bank. 

Credit limit increases amount to $160 billion in new credit each year in the US, the study finds. Critically, banks are more likely to increase limits for “revolving borrowers who carry balances month-to-month”.

The prevalence of limit increases in the US is consistent with lenders implementing “low-and-grow” strategies, the authors say. These strategies involve issuing credit cards with low initial limits to borrowers with lower credit scores, and then increasing the limits based on borrowers’ behaviour.

The authors find that, on average, subprime borrowers take out cards with $700 limits, which rise to $2,700 over five years. Even when consumers had not been near their previous limits, they would increase their spending after the limit had been increased. 

“If some consumers struggle with self-control, algorithmic limit increases may encourage additional borrowing and thus be profitable for banks but potentially harmful to vulnerable consumers who end up with more debt than they would have chosen otherwise,” write the authors.