The Truth-in-Lending Act, passed in 1968, requires full and clear disclosure to borrowers of the terms of bank lending. Interest rates charged on bank credit cards subsequently remained much higher than the cost of funds and have tended not to follow occasional declines in other interest rates.

Some observers interpreted this pattern as indicating imperfect competition, possibly of a sort that could be alleviated by stronger disclosure requirements. Following this logic, Congress passed the Fair Credit and Charge Card Disclosure Act, which took effect in 1988 and strengthened mandatory disclosure specifically for credit cards.

In this case, whether the first condition (an existing problem) was met remains a controversial issue. Some studies (e.g., Lawrence Ausubel, "The Failure of Competition in the Credit Card Market," American Economic Review, March 1991) have concluded that persistently high interest rates on credit cards could constitute evidence that the credit card market is not perfectly competitive. The historical fact that banks' credit card operations have been more profitable than other bank products, on average, further supports this view, as do certain statistical tests of pricing behavior.

However, other studies have concluded that the observed pattern of interest rates may be consistent with competitive pricing (e.g., Glenn Canner and Charles Luckett, "Developments in the Pricing of Credit Card Services," Federal Reserve Bulletin, September 1992).

If the market for credit cards was fully competitive, there was no problem to be solved and, hence, no potential benefit from added disclosure requirements.

Moreover, if credit card issuers have market power, its source must be determined before we can judge whether increased disclosure will reduce it. Since the market for credit cards is nationwide and there are about 5,000 issuers in the U.S., we might expect vigorous competition apart from special factors. Economists have identified two main conditions that might allow card issuers to exercise some market power in this case: consumer search costs and switching costs.

According to the first of these explanations, banks are able to charge high interest rates because it is difficult for consumers to learn about other banks that charge lower rates. In this situation, increased disclosure would make it easier for consumers to shop around, eventually forcing all banks to match the lowest rates. This was the argument presented in Congress supporting the expanded disclosure requirements that took effect in 1988.

According to the second explanation, it is costly for a consumer to transfer her credit card account to another bank, especially if there are outstanding balances on the old card that must be paid off before the new bank will approve the application. In this situation, any anticipated savings from a lower interest rate must be large enough to outweigh the switching costs before a consumer will change to the bank with the lower rate.

Therefore, a bank can retain many of its existing credit card customers even if it charges somewhat higher interest rates than other banks and even if its customers are aware of that difference. Increased disclosure would primarily affect the competition for new customers and therefore would have less of an impact on interest rates than if there were no switching costs. Historical evidence that switching costs are important in the market for credit cards was found by Paul Calem and Loretta Mester (Federal Reserve Bank of Philadelphia Working Paper 92-24, "Search, Switching Costs, and the Stickiness of Credit Card Interest Rates.")

Since the Fair Credit and Charge Card Disclosure Act of 1988, spreads and profits on credit card operations have remained high relative to other bank products and services. A recent empirical study provides additional evidence that the pricing of credit cards has been substantially noncompetitive, on average, from 1988 through 1993. In fact, it has been no more competitive than in the years immediately preceding the expanded disclosure. (Sherrill Shaffer, Federal Reserve Bank of Philadelphia Working Paper 94-16, "Evidence of Monopoly Power Among Credit Card Banks.")

The average profitability of credit card banks grew steadily relative to assets in at least the first three years after 1988, while the gap between interest rates charged on credit cards and those on automobile loans, personal loans, or Treasury bills has widened since 1989.

Thus, the recent experience suggests that the Fair Credit and Charge Card Disclosure Act of 1988 has not increased the degree of competition, possibly because consumer search costs were not the primary reason for market power in credit cards.

Mr. Shaffer is an assistant vice president in the supervision, regulation, and credit department of the Federal Reserve Bank of Philadelphia. His comment is excerpted from article in the May-June issue of the bank's Business Review.

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