Why Do Banks Allow Credit Card Credit Limits to Exceed Salary
Banks often allow credit card credit limits to exceed a borrower’s salary for several reasons. This practice is not only based on a borrower's monthly salary but also on a wide range of financial indicators. Let’s explore the key factors in detail.
Creditworthiness Assessment
Banks evaluate a variety of factors beyond just salary, such as credit history, debt-to-income ratio, and overall creditworthiness. A person with a strong credit history can demonstrate financial responsibility and manage higher credit limits. Even if an individual's salary is relatively modest, a positive credit profile can justify a higher credit limit.
Potential for Increased Spending
Banks aim to maximize their profits through interest and fees. By offering higher credit limits, they can encourage consumers to spend more, leading to higher interest payments if the balances are not paid in full. This strategy not only increases revenue but also drives consumer engagement with the bank's financial products.
Risk Management
Banks use sophisticated algorithms and models to assess risk. They may determine that an individual can manage a higher credit limit based on their payment history and financial behavior, even if their salary does not fully justify it. Factors such as a borrower's payment behavior, credit utilization, and finacial stability are considered. For instance, borrowers who regularly pay their bills on time and maintain a low credit utilization ratio may be offered higher credit limits despite lower salaries.
Customer Retention and Competition
Offering higher credit limits can be a competitive strategy to attract and retain customers. In a saturated market, banks that provide more generous credit limits can have a competitive edge. Consumers often choose banks that offer more favorable credit terms, which can lead to long-term relationships and increased loyalty.
Income Variability
Many individuals have income sources beyond their salary, such as investments, bonuses, or part-time jobs. Banks consider all sources of income when determining credit limits. For example, a finance professional with a stable salary and additional income from real estate investments might be granted a higher credit limit.
Impact of Credit Utilization Ratio
Higher credit limits can help improve a consumer’s credit utilization ratio, which is the amount of credit used compared to the total available credit. A lower credit utilization ratio is generally more favorable to a borrower's credit score. Banks understand that allowing higher credit limits can help clients maintain a good credit score by keeping their credit utilization low.
However, it is important to note that credit limits can vary from country to country. For instance, in Malaysia, the maximum credit limit extended to a cardholder cannot exceed twice the holder's monthly income per credit card issuer. Cardholders can only be a principal card holder from a maximum of two credit card issuers.
From a personal experience, credit limits on my cards are a fraction of my annual income. It is common for credit limits to be a few times the monthly salary, often 2 to 3 times. This practice is based on a combination of the individual's financial behavior, credit history, and overall financial stability.
In summary, while salary is an important factor, banks consider a broader range of financial indicators when determining credit limits. This comprehensive approach allows them to offer higher credit limits to borrowers who demonstrate financial responsibility and stability, regardless of their salary alone.