Credit cards are one of banking's most profitable businesses, earning 10% of the industry's record $43.4 billion in profits for 1993, while making up only 5% of its assets.

But across the industry, there is concern that juicy profits of the past may diminish as interest rates continue to rise and the cost of funds creeps up. As a result of the rate hike, consumers may use their cards less, pay off their balances, and continue to shop for the best deals.

Since 1992, most banks have switched to variable interest rates, giving the banks the option to raise credit card interest as the prime goes up, from 6% over the past two years to 7.25% today. Experts say this will keep profit ratios - running about 2.2% of outstandings after tax - at the same level.

But as formula increases go into effect, no one knows how the consumer will react.

'Consumer Backlash'

"Everyone is in a wait-and-see mode, but there will be consumer backlash," predicted Robert B. McKinley, president of RAM Research Corp. in Frederick, Md.

Part of the problem, noted Anne Morgan Moore, president of Synergistics Research Corp., Atlanta, is that many consumers believed they had a fixed-rate card. "Now that rates are going up, consumers are becoming aware they have a variable rate," she said.

Although many consumers have researched the market, discovering good deals, many consumers have not. "This could set off the second wave of rate shopping," warned Mr. McKinley.

Marc Altman, senior vice president of marketing and sales, First of America Bank Corp., said that rates would have to increase significantly to provoke the public.

Mr. McKinley disagreed. "Issuets would love to see consumers swallow this increase. I don't think that's going to happen."

A saturated market makes for cutthroat competition. In the past, banks were creating market share, today they're stealing it.

"This is a level of competition this industry has never seen," Mr. McKinley said "and it ain't over yet."

Shrinking Pie

As more competitors flock to cobranding, the market is being sliced into smaller pieces. "I think that some banks will seek an advantage in the rising interest environment by either holding their rates or coming out with new products to garner some of the business that will be shifting around," said Chris Fredrick, senior vice president, strategic planning, MasterCard International, New York.

But that would be tantamount to buying market share, and would be too expensive to maintain.

"Issuers will have to do some things to improve profitability," said Robert K. Hammer, chairman and chief executive officer, R.K. Hammer Investment Bankers, a Newbury Park, Califbased card consultancy. "The first thing they can do is activate inactive accounts, using rewards, bonus points and sweepstakes."

The average cost of acquiring a new account is $75 to $125. It is cheaper and more efficient to keep current customers. "To stop attrition, provide more value," Mr. Hammer said.

Marketing Tuneup

Banks have been offering value-added rewards for years. But through new technology that tracks purchase behavior, financial institutions can give their customers discounts on items they want and need. Mr. Hammer said that banks are beginning to apply this technology to their marketing techniques.

"We have a customer analytic data base which we use to determine what kind of offers would be attractive to our customers," Mr. AIrman said. "We want to make the right and relevant offers to our customers."

Although it may be an expensive proposition, Mr. Altman called it the cost of doing business. "It's part of what's required to not have our customers changing cards."

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