Credit card limit reduced? Here's what might have triggered it

To avoid damaging your credit score and falling into debt, it's essential to repay your credit card dues in full each month

Imagine receiving a surprise notification from your bank informing you that your credit card limit has been reduced. You're left wondering what triggered this change and how it will impact your finances. But banks don't arbitrarily slash credit limits. There are specific reasons behind this decision, ranging from changes in your credit score to shifts in the bank's risk assessment.

Let's delve into why banks reduce credit card limits and what you can do about it.

Defaults on repayment of credit card dues

Data from TransUnion Cibil reveals a notable rise in credit card defaults, from 1.6 percent in March 2023 to 1.8 percent by June 2024. This uptick is largely driven by the increasing popularity of Buy Now, Pay Later (BNPL) schemes and easy e-commerce instalment plans, especially among young millennials. Furthermore, TransUnion Cibil reports that India's outstanding credit card dues have risen to Rs 2.7 trillion by June 2024, up from Rs 2.6 trillion in March 2024 and Rs 2 trillion in March 2023.

This alarming trend signals a growing concern of escalating credit card debt and rising defaults among borrowers.

Repeatedly delaying credit card payments can lead your card issuer to perceive you as a high-risk borrower, potentially resulting in a reduced credit limit. Furthermore, your credit score is also impacted by your payment habits. Making timely credit card payments can boost your credit score, while late or missed payments can significantly lower it.

To avoid damaging your credit score and falling into debt, it's essential to repay your credit card dues in full each month. Paying only the minimum due amount can lead to a debt trap, as interest accumulates on the outstanding balance. By paying the full amount, you can maintain a healthy credit score and avoid financial complications.

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Rising delinquencies at card-issuing banks

As delinquencies rise, banks face increased risk exposure. Delinquencies signal that a growing number of cardholders are struggling to repay their debts, prompting banks to reassess their lending strategies. When delinquencies surpass comfortable thresholds or economic uncertainty looms, banks tighten their credit policies to mitigate potential losses.

As a result, cardholders perceived as higher credit risks may experience unexpected actions, such as reduced credit limits or stricter repayment terms. This is particularly true for those on the lower end of the credit risk spectrum, who may be caught off guard by these changes.

High credit utilisation ratio

The credit utilisation ratio is a crucial metric that measures the proportion of available credit being used. It's calculated by dividing the total amount spent by the total credit limit. For example, if your credit card has a limit of Rs 1 lakh and you spend Rs 40,000, your utilisation ratio is 40 percent.

Maintaining a low credit utilisation ratio (ideally below 30 percent) demonstrates responsible credit behaviour. Conversely, high utilisation ratios (above 70 percent) can raise concerns for lenders. Frequent high utilisation can lead to reduced credit limits, as lenders view borrowers with high utilisation ratios as riskier. A high utilisation ratio may indicate over-reliance on credit and difficulty in managing debt, making lenders cautious about extending additional credit or offering favourable terms.

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Increase in credit limit drastically

Accumulating multiple credit cards over time can significantly increase your total credit limit. However, this rapid growth can raise concerns for banks, which may view you as a risky credit profile. To mitigate this risk, banks may reduce your credit limit.

Banks obtain this information from credit bureaus, which track your credit history and total credit limit. For example, if you initially had 10 credit cards with a total limit of Rs 50 lakh, and then acquired 10 more cards, doubling your total limit to Rs 1 crore within a short period, some banks might consider reducing your credit card limit to minimise their risk exposure.

Economic uncertainty

During times of economic uncertainty and financial crisis, credit card issuers often take a cautious approach by reducing credit limits for their cardholders. This proactive measure aims to mitigate potential losses, as the likelihood of cardholders defaulting on payments increases in such situations. A notable example of this is the Covid-19 pandemic, where many credit cardholders experienced reduced credit limits as a result of the economic downturn.

Inactive card

Infrequent credit card usage can lead to a reduced credit limit. Since card issuers generate revenue through transaction fees and interest charges, inactive accounts are less profitable. If your card remains dormant for an extended period, your bank may choose to reallocate your credit limit to a more active cardholder, increasing the likelihood of earning revenue through charges and interest rates.

What should you do if your credit card limit is reduced?

If your bank has reduced your credit limit without prior notice, it's essential to reach out to its customer care department to understand the reason behind this decision. Ask the bank to share its concerns, and then explain your side of the story. If you've missed payments due to genuine reasons, provide context and request that your original credit limit be reinstated. By contacting the bank's customer care, you may be able to resolve the issue and have your credit limit reinstated.