How does the Fed Rate hike impact Card Cashback in 2023?

Recent increase in Fed Rates

For a long time, the US Federal Reserve has always kept the interest rates near zero, below 1% from December 2009 till April 2017. However, since 2022, the Fed has increased the rates consistently to tackle the rising inflation.

The Fed did provide some relief when it lowered its interest rates from 4th May 2020 to 23rd May 2022. Then again, thanks to the ever-raising inflation over the last year, the Fed had to raise interest rates by 450 basis points. The latest rise happened on 22nd March 2023, when the Fed raised the interest rates by 25 basis points, and it currently stands at 4.58%.

Why is the Fed increasing interest rates?

Inflation has skyrocketed in the US post-pandemic. Typically, US witnesses average inflation of 1-2%; however, in 2021, it witnessed a inflation at an rate of 7%, more than double the rate that it usually witnesses, forcing the Fed to raise interest rates. 

As a result, the Fed plans to continue raising the rates till they bring down inflation rates below their target of 2%. Currently, the annual inflation rate for the previous 12 months ended on February 2023, stands at 6%.

For the uninitiated, here’s how an increase in the interest rates by the Fed helps to control inflation.

• Rising interest rates control the money supply in an economy by increasing the cost of credit, forcing people to reduce borrowing.
• People are also incentivized to save more to earn higher returns 
• It thereby reduces the money supply in circulation, reduces demand and economic activity and results in lowering inflation.

How do these changes impact your card points and cashback?

While Fed’s increased rates impact various things, most people don’t understand the impact it can have on the cashback and reward points companies earn on their card transactions.

History of cashback 

The world of corporate card spend was changed with the introduction of cashback. Many companies were given incentives in the form of extremely high cashback for using cards for their purchases. In 2021, Airbase was offering 2.25% as cashback on pre-funded cards and 1.75% on charge cards. Around the same period, Ramp was offering 1.5% cashback. 

Another company in the spend management and cards space, Brex, gave reward points instead of promising cashback to encourage customers to spend on cards. These points could be used for software and tools or redeemed against services like Uber. 

Boom in corporate spend cards

Spending on these corporate cards thus, was a win-win for all parties involved. For every transaction a customer made on a card, the customer earned an average of 1.5-2% cashback. The card issuing company also earned a percentage of the transaction value. The proposition of earning on every spend along with the working capital benefits of a 30-day float, made this concept exciting for many SMBs. At the same time the companies issuing these cards benefited from spend volumes and customer base increasing 10-15x year on year.

Impact of increase in interest rates

But with the consistent rise in interest rates, the trend of high cashback increasingly became unsustainable since cashback is directly linked to interest rates. 

When a customer does a transaction on a card, a percentage of that value is charged to the merchant who accepts the card payment. This per cent is split between the card issuer (Brex, Airbase, Ramp), a bank backing the issuing company, and card networks (Visa, Mastercard). 

Card issuers fund the transaction immediately on the customer’s behalf and eventually collect the money from customers at the end of 30 days (or other credit period). In order to fund this, the issuers put their own funds or borrow funds/debt financing. This cost of debt is set off against the per cent of revenue they earn per transaction.

As interest rates rise, the debt cost increases and the profit share reduces to a sliver. Because of this, these spend management companies are constantly decreasing their cashback percentage and devaluing their card points.

Recent developments

In November 2021, Airbase announced 2.25% on charge cards and 1.75% cashback on prepaid cards. In the first half of 2022, it quietly reduced its cashback not once but twice. A month back, it slashed the credit limits of its customers to anywhere between 20-30% because of the deteriorating unit economics of the charge card business. It also requested customers to deposit money to ensure charges would not be declined, and they are able to continue using their Airbase-issued charge cards.

Immediately after the SVB crash, Brex also devalued cash and crypto redemptions by 40% and slashed reward points transfer rates by 40%. Thus, its customers will now get 0.6 cents instead of getting 1% point in value.

How much will the Fed raise rates in 2023?

With the crash of SVB and Signature Bank, the forecaster’s opinions are divided on whether the Fed will hit a pause on rising interest rates or continue doing so till they hit their inflation target. To sum it up, companies will now have to decide if paying by card continues to make sense for them or not based on what the Fed decides.