Competition for high-spending business travelers led banks to offer airline loyalty points as rewards. This cross-subsidization, funded by interchange fees, became so profitable that the loyalty programs are now worth more than the airline carriers they partner with.
First Republic intentionally provided unsecured loans at below-market rates to attract young, high-earning professionals. The bank absorbed the initial loss on the loans, knowing these customers would soon have large deposit balances that were far more profitable and would ultimately self-fund the loan program.
If an APR cap were enacted, banks could not price for the higher default risk of lower-credit customers. To de-risk their portfolios, they would likely respond by closing accounts or slashing credit lines for these segments, ultimately harming the very people the regulation aims to help.
The fight for desirable credit users is so fierce that for customers in the middle-to-upper range of credit scores, the cost of rewards and cash back exceeds the revenue generated. Profitability only returns for the highest-spending users whose interchange fees outrun the reward expenses.
A credit card is not a single product but a complex bundle of services like loans, payments, and insurance. Its profitability relies on cross-subsidization, where revenue from one area (e.g., high interchange from a frequent traveler) covers losses or lower margins in another (e.g., providing rewards).
Interchange is not just a transaction processing cost. It's pitched to merchants as a fee for bringing them desirable, high-spending customers who use a particular card brand, analogous to paying for an advertisement that drives business. The card issuer receives the largest share for taking on the risk and acquiring the customer.