Charge of The Plastic Brigade

By Janice Castro

The credit-card business used to be a nice, easy way for lenders to earn profits. No longer. The industry has become fiercely competitive and increasingly controversial. More and more players are trying to steal customers from their rivals by offering everything from memberships in private clubs and sweepstakes prizes to cut-rate interest rates. At the same time, the public is complaining about the high interest rates that come with their cards, and politicians are threatening banks and credit-card companies with restrictive legislation.

A new tempest arose in the industry last week when American Express, which already has 17 million U.S. cardholders, unveiled a new card called Optima. To the chagrin of competitors, Amex is charging users of the Optima card an interest rate of only 13.5% on their outstanding balances, far below the 18% to 22% that is typically charged by major banks and department stores. Though Optima will be available only to established American Express cardholders with good payment records, credit-card experts say it could draw a significant amount of business away from banks. John Pollock, editor of the Bank Credit Card Observer, an industry newsletter, predicted that Optima will unleash a "Boston Tea Party of consumers dumping expensive cards and moving to cards with lower rates."

Up until now, the credit-card lenders have had fairly well-defined turfs. On one side are the so-called travel-and-entertainment cards, including American Express and Diners Club. Customers who use these cards are expected to pay for their purchases within 30 days. No interest is charged, but penalties are assessed if payments are excessively late. On the other side are Visa and MasterCard. These cards are administered by national companies but issued through individual banks. Customers may make minimum monthly payments, but steep interest rates, determined by the banks, are charged on outstanding balances.

By introducing its new card, American Express has dramatically changed the terms of the competition and thrown the industry into a tizzy. Reason: while charging its lower interest rate, Optima will operate exactly like a bank Visa card or MasterCard. The banks are outraged by this intrusion into their domain, and the competitive battle promises to get nasty. Last week C.T. Russell, president of Visa, sent an urgent Mailgram to banks that issue his company's cards. Wrote Russell: "You might call ((American Express Chairman James)) Robinson and voice your displeasure over his decision to enter one of your most profitable lines of service. Second, you may wish to rethink your position in offering American Express products." That was a not so subtle suggestion that banks stop selling American Express traveler's checks, among other Amex services.

Banks may also face formidable new competition from retailers, who have traditionally issued cards only for use in their own stores. Two years ago, Sears introduced its Discover card, which can be used in 550,000 stores, hotels, gas stations and other outlets nationwide. Already 12 million customers carry the Discover card, which could become the model for other entrants into the credit-card fray.

The American Express Optima card will undoubtedly add to the intense pressure being put on banks and department stores to reduce their interest rates. Across the U.S., public officials and consumer groups are angry that credit-card charges have stayed high in recent years while other lending rates have sharply dropped. Two bills have been introduced in Congress that would establish national ceilings for credit-card interest. Six states -- Arkansas, Connecticut, Rhode Island, Texas, Washington and Wisconsin -- already limit that interest.

Last week Illinois State Treasurer Jerry Cosentino closed state accounts at the American National Bank of Chicago, in which about $485 million is deposited annually. The bank had refused to lower its credit-card interest rate from 19.8% to about 14%. American National was the second Illinois bank to be hit with such a sanction by Cosentino.

Another irritation for some consumers is that banks are changing the rules about interest payments. Traditionally, for example, Visa and MasterCard holders have had 30 days in which to pay their bills in full before finance charges began. Now, however, dozens of banks have started to charge interest as soon as purchases are made.

Perhaps the most significant change adding to the turmoil in the credit- card industry is the advent of tax reform. Some experts think the new law will slow down the use of plastic credit because it phases out deductions for interest on card balances. But some banks are getting around that problem by linking Visa cards or MasterCards to a home-equity credit line. Interest on these home loans is still fully deductible. Customers can therefore get a credit line against their homes that permits them to run up as much as $100,000 in interest-deductible card charges. But, warns Edward Kramer, senior vice president for the Dime Savings Bank of New York, which offers such a Visa card, "it's important to remember that this is a lien on your home."

As competition in the credit-card business intensifies, many lenders are blatantly trying to lure customers from rivals. People's Bank of Connecticut, which charges an unusually low 11.5% interest on its MasterCard, will lend people the money they need to pay off other credit-card balances and switch to its card. Buffalo-based Empire of America bank now offers its customers a novel choice. They can pay 18% interest on purchases with a Visa Classic card and enjoy the traditional 30-day grace period, or they can pay just 13.7% on a Visa Lite and tote up interest from Day 1. Tastes great, but it is more filling.

With reporting by Gisela Bolte/Washington and Joseph N. Boyce/New York