When Credit Card Holders Open a Second Line of Credit, What Does It Signal to Their Original Card Issuer?

Credit cards are readily available, do not require collateral, and pose few administrative complications. This makes them common among borrowers — especially new ones, whose oldest credit instrument is less than six months old. When these early-stage consumers open a credit card, their action becomes one of the founding elements of their credit profile. This makes them particularly interesting to economists.

The modern-day credit profile is largely based on payment history, so paying off your debts on time is one way to access both more credit and credit on better terms. But there's another way borrowers can improve their access to credit. Credit card holders who open a new credit card are often rewarded with a higher credit limit on their original card. Strikingly, the borrowers who receive larger additional credit lines are not more likely to become delinquent in the future. These and other surprising findings are reported in “Building Credit Histories,” a new paper by Natalia Kovrijnykh, Igor Livshits, and Ariel Zetlin-Jones.¹

Most credit card issuers, the authors find, are signal-detection machines that collect and synthesize information from diverse sources to decide which borrowers deserve a higher credit limit. And, as the authors report, issuers tend to view borrowers with a short credit history in a unique light when they are awarded a second line of credit. Notably, issuers view the second line as a positive signal about these new borrowers. This conclusion is corroborated by data showing that, on average, emerging borrowers who receive a second credit card are not at significant risk of defaulting on their credit lines. In fact, these borrowers turn out to be quite creditworthy. The sequence of events can be simplified as follows: Having received credit card A, a borrower applies for (and is granted) credit card B. The issuer of credit card A then increases the borrower’s credit limit, having interpreted credit card B’s offer as a positive signal about the borrower.

To focus more intensely on the notion that credit card issuers are motivated by what other credit card issuers do, the study looks at “the exact timing of when a borrower opens a new card,” tracking the month in which the new card is opened and measuring the fluctuations in the borrower’s credit limits before (and after) that month. When plotted on a graph, the results show that incumbent credit card issuers increase credit limits in the month(s) following the issuance of the new credit card. Meanwhile, during the months before the new card is opened, credit limits remain relatively unchanged. “This observation,” the authors write, “is another piece of evidence that information about the borrower’s creditworthiness may be contained in her getting a new card, especially for emerging borrowers.”

The picture drawn by the authors, in which newer borrowers are awarded substantial credit increases, is even more compelling when considering the study’s aggregate results. Incumbent lenders are shown to increase aggregate lending by nearly 143 percent for borrowers who open a new credit card, while borrowers who forgo a new card are only awarded an aggregate increase of approximately 23 percent.

Results like these, the authors say, reinforce the likelihood that “borrowing from one lender may lead to an improved assessment of the borrower’s creditworthiness by other lenders.” They base their findings on their analysis of the credit card activities of a sample of 1 million borrowers (drawn from real-world data sets provided by TransUnion, a credit reporting agency). Through a rigorous matching process, the authors tracked credit card issuance for each specific borrower, mapping how their credit limits changed from 2014 to 2017. For comparison purposes, the anonymized data contain 500,000 emerging borrowers and 500,000 established borrowers.

Throughout their paper, the authors help us put their findings into context, offering interpretations that crystallize the relationships they observe. The authors emphasize, for instance, that what borrowers are doing when applying for a new credit card might be best characterized as building a credit history as opposed to improving a credit score. This means that borrowers are acting with intent — a finding that contrasts with much of the historical research in this area, which puts a low priority on borrower intent.

Another contextualization the authors put forth is that financial markets, especially those for consumer credit, are remarkably good at collecting information and adjusting their conclusions fluidly. Over time, markets become dense networks of signals, and lenders (including credit card issuers) use those signals to refine their assumptions about which borrowers are more creditworthy than others. In addition to the signals analyzed in “Building Credit Histories,” examples of signals come from sources that might seem unorthodox to a dyed-in-the-wool credit analyst of an earlier generation. One source, for instance, is the pervasive digital footprint that consumers leave behind in today’s hyperconnected society. Clickstream data, social network data, and so much more coalesce into indicators that “are particularly important for emerging borrowers who have little or no formal credit history.”

In laying out the credit-market behavior described in their work, the authors offer a new interpretation of the signaling mechanisms credit card issuers rely on when lending to emerging borrowers. Their paper helps us appreciate that credit card issuers, having long lionized traditional credit scores, can turn to other, perhaps more-nuanced markers of a person’s credit history. As Kovrijnykh, Livshits, and Zetlin-Jones show, a new line of credit is one such marker. After all, “the informational content of an additional credit line is larger for emerging borrowers than for established borrowers, whose credit records contain a wealth of other information.”