Credit card issuers in the United States may have nowhere to hide as they face heavy-handed government intervention this year, thanks to a legislative and regulatory crackdown on what consumer groups and some lawmakers in the U.S. consider to be unfair industry practices.
The legal and regulatory activity comes after years of consumer
complaints about confusing card policies that critics say are designed to trap cardholders at every turn with short payment deadlines, late fees,
over-limit fees and other penalties that drive up interest rates.
Consumer-advocacy groups say they worked for years to get lawmakers' attention on these problems, but issuers always seemed to skirt sanctions. Things came to a boil last year, when consumer complaints reached a fever pitch, prompting a series of congressional hearings on credit card practices. The hearings spawned legislation introduced this year designed to end card practices certain lawmakers deem abusive See chart.
Though several of the proposed laws are still in the committee-discussion phase, the congressional hearings helped trigger unprecedented action this spring by federal banking regulators.
Citing testimony from the hearings, the Federal Reserve Board, Office of Thrift Supervision and National Credit Union Administration in May released proposed rules on Unfair or Deceptive Acts or Practices under the Federal Trade Commission Act, marking the most-sweeping rules changes in recent history for the credit card industry. The proposal's comment period ends Aug. 4, and the agencies say they expect the rules to go into effect before the end of this year.
The Fed also is gathering comments through July 18 on changes to Regulation Z, which implements the Truth in Lending Act. Those changes would simplify and clarify the way issuers must disclose the details of their credit card agreements in card applications and solicitations.
The agencies' proposed rules on unfair practices would ban some of the same credit card practices that are under fire in various legislative proposals. They also are a source of serious concern to issuers.
"If the federal rules go into effect as they have been proposed, it will hurt bankcard issuers' margins to some extent," says Dennis Moroney, senior analyst at Needham, Mass.-based TowerGroup, MasterCard Worldwide's research arm.
However, determining the extent to which issuers' revenues would be affected is difficult because issuers' policies vary, as does the mix of customers in their portfolios, Moroney notes. "Penalties and interest represent a good chunk of some issuers' revenue, especially those with a high proportion of customers who tend to revolve balances month after month," he says.
Mitchell Uretsky, a managing associate at Auriemma Consulting Group, a Westbury, N.Y.-based financial services consultancy, speculates that it could be costly to revamp the back-office process for setting due dates for bills and allocating payments to higher, instead of solely to lower, interest rates.
Card issuers simultaneously are facing legislation this year that would cut back credit card interchange rates, potentially dealing a serious blow to another important revenue source.
"The amount of legislative and regulatory attention paid to the
credit card industry this year tells you that something is not quite right with the industry's relationship with consumers," says Adam Levitin, associate professor of law at Georgetown University whose research focuses on financial-services regulation and competition. He was among several consumer advocates who testified in March before the House Financial Services Subcommittee on Financial Institutions and Consumer Credit during a hearing on credit card practices.
"The question that remains open is whether the card industry can clean up its own act without Congress getting involved in more new rules and laws," Levitin says.
If the Central Bank's rules are enacted as proposed, consumers would get an extra week from the time issuers mail their bills to when the payment is due. The payment cycle would move to 21 days from as little as 14 days currently.
Consumer advocates say two weeks is too narrow of a window. If cardholders are traveling or if their mail delivery is late, consumers could miss payment deadlines during routine payment cycles. And this could result in late fees averaging $39, finance charges based on the amount of new charges and possible penalization with higher interest rates.
The Fed's rules also would prohibit issuers from increasing the interest rate on an outstanding balance unless the balance is tied to an index or variable rate, if a promotional rate expires, or if the minimum payment is not received within 30 days of the due date.
Consumer advocates say this provision would eliminate a major source of headaches, as consumers frequently are slapped with higher penalty interest rates on outstanding balances because their payments arrive a few days, or even a few hours, late.
The Fed's proposed rules do not directly address "universal default," defined as when an issuer raises a cardholder's interest rate because credit-bureau data reveal deteriorating credit, such as heavier borrowing or making late payments to third parties or missing payments.
Many issuers say they have voluntarily ended their reliance on universal default, although Bank of America Corp. confirms that it continues to use credit-bureau data to adjust cardholders' interest rates on outstanding balances.
Another significant provision of the Fed's proposed rules is a ban on issuers applying cardholders' payments first to the lowest annual percentage rates on card balances.
Many cardholders have multiple interest rates on a single card account, such as higher rates for cash advances and lower, short-term promotional rates. Nearly all major issuers currently apply above-minimum payments to the lowest balances first. The proposed rules steer issuers toward applying above-minimum payments equally among balances with different interest rates, or on a calculated basis.
The agencies' proposed rules also would end "two-cycle" billing, in which interest is calculated for the current billing cycle on charges made in a previous billing cycle. Consumer advocates say most major issuers have ended this practice. Discover Financial Services says it continues two-cycle billing with some of its accounts, but it allows new accountholders to opt out.
The proposed rules do not address "any time, any reason" interest-rate repricing, which is a feature in some legislation. Most issuers give cardholders at least 30-days warning of impending interest-rate increases, and consumers may notify issuers to decline the rate. At that point, cardholders can pay off their balance at the old rate, but any new charges would be at the new, higher rate.
But cardholders complain that issuers trap them with higher interest rates during this process by sending notices of interest-rate hikes separate from billing statements in inconspicuously marked envelopes that consumers easily could confuse with ubiquitous privacy-policy notices or junk mail. As a result, many consumers do not learn about the new, higher interest rates until their next statements arrive with charges at the higher rate.
Pending legislation would give cardholders as many as three billing cycles to decline new rates before they take effect.
Auriemma's Uretsky says the federal agencies' proposed rules could blunt the momentum of legislation to curb abusive card practices.
"The Fed's proposed changes are watered-down versions of the legislative bills ... (that) will likely cause Congress to back off a little, especially with Congress going into a summer recess followed by activities leading up to the November election," he says. "Depending on the outcome of the election, the legislative landscape could change significantly."
Consumer advocates agree that new national political leadership this fall could prompt new versions of existing laws, including the combination of some proposed laws.
Individual card issuers did not venture comments beyond prepared statements about the proposed Fed rule changes or pending legislation that could affect their card programs.
Asked for its reaction to the legislation against certain credit card billing practices and the agencies' proposed new rules, Citigroup Inc. said in a statement: "The Federal Reserve's comprehensive proposal to reform credit card practices eliminates the need for legislative action."
Other card-industry representatives oppose both legislation to curb credit card issuers' policies and the federal agencies' proposed rule changes, warning the measures
likely would have unintended consequences.
The American Bankers Association calls the Fed's proposed rules "an unprecedented regulatory intrusion into marketplace pricing and product offerings," warning that restricting issuers' ability to charge interest rates based on individual consumers' risk profiles ultimately would raise credit card interest rates.
Access To Credit
Carlos Minetti, executive vice president of cardmember services and consumer banking at Discover Financial Services, testified before the House Subcommittee in April. In a statement, he said the legislation and the Fed's proposed rules "prohibit a number of longstanding practices ... (that) provide borrowers who have less-than-perfect credit histories with access to credit that they would not otherwise find from mainstream lenders. ... These proposals would jeopardize access to credit for many consumers and will raise the cost of credit for most credit users."
Many issuers say the provision preventing them from allocating minimum payments only to balances with the lowest interest rates would kill low- or zero-interest-rate offers.
"Requiring a pro rata allocation of payments on accounts with multiple balances at different [annual percentage rates] prolongs the time period during which zero or low-APR-loan balances will be repaid," Minetti said. "This changes the economics of offering low-APR introductory or balance-transfer offers. It will result in the elimination or reduced availability of balance-transfer offers."
Asked for its reaction to legislation that would restrict card practices and the Fed's proposed new rules for issuers, American Express Co. said in a statement: "We believe some of the changes could have an impact on our business and could also result in less choice for consumers, such as fewer promotional rates and less access to credit."
Consumer advocates cheer some of the proposed federal rules, but they say the proposed changes do not go far enough. They also say they are unsure how the new rules would affect efforts to push through legislation against what they consider to be abusive credit card practices.
"For many years, we asked the government to step in and stop unfair credit card practices. But when the regulators suddenly jumped in with new rules this year, we were surprised and a little bit unprepared," says Linda Sherry, director of national priorities in the Washington, D.C. office of Consumer Action, a nonprofit consumer education and advocacy organization based in San Francisco.
Sherry, who testified before the House Subcommittee on Financial Institutions and Consumer Credit in April, says some of the federal agencies' proposed rules are "quite good" but do not cover all of the industry's allegedly abusive practices, such as "any time, any reason" changes in credit card terms. Her organization continues to support more "comprehensive" legislation to end card-industry abuses, Sherry says.
Travis B. Plunkett, legislative director for the Washington, D.C.-based Consumer Federation of America, calls the agencies' proposed rules "a good first step in dealing with some of the card industry's abuses." But he agrees with Sherry that the proposed rules do not address all of the areas where card issuers can generate hidden or unfair fees.
"Still, the regulators have a better chance than legislators of anticipating end-runs (by issuers), and frankly it takes less time for regulators to implement rules than for legislation to go through," Plunkett says.
Consumer advocates harp that penalty fees are a heavy burden for cardholders, and they note that card issuers' penalty-fee revenue (from late, over-limit and other fees) rose sharply last year compared with 2006, according to Cards&Payments' research ("Exclusive Bankcard Profitability Study and Annual Report," May).
But penalty fees are a relatively small piece of issuers' revenue. Penalty-fee revenue totaled $7.54 billion last year, up 17% from $6.44 billion in 2006. It represented 6.4% of card issuers' overall revenues, up from 5.6% in 2006.
By contrast, credit card interest totaled $75.45 billion last year, up only slightly from $75.15 billion in 2006. Interest's share of issuer revenue was 63.9%, down from 65% in 2006.
Interchange revenue totaled $23.56 billion in 2007, up 3% from $22.83 in 2006. It represented 20% of issuers' overall revenue last year, up slightly from 19.9% in 2006.
An estimated 45% to 55% of credit card customers routinely carry a balance from one month to the next, say credit card industry analysts, down from about 65% of cardholders who routinely carried a balance in the mid-1990s.
More consumers are migrating to debit payments, including young consumers and those over age 60, and more overall have learned to segment their payments so there is less reliance on credit, says Ali Raza, executive vice president of Speer & Associates, an Atlanta-based financial consulting firm.
Return To Annual Fees?
"Those who are at the lower end of the income spectrum tend to revolve balances and pay more interest and fees," he says. "If the Fed forces issuers to soften those fees, we will likely see new types of fees pop up elsewhere, spread out among all cardholders."
To compensate, issuers may create new fees for certain services, or there may be a return to annual fees on all credit cards, regardless of whether cardholders revolve a balance, Raza says.
Consumer advocates say they are not worried about card issuers cutting off credit to consumers.
"Credit card systems have shown themselves to be very resourceful in terms of maintaining quite-handsome profits over the years," says Plunkett of the Consumer Federation of America. "Credit cards are always the most profitable part of any bank's operations, by a factor of two or three, and I have no doubt they will continue to be successful. Our interest is in making this a more fair system for consumers."
The Fed's proposed new rules likely will drive changes in some card-industry practices. Combined with other pending legislation, including interchange-rate regulation, this year's crackdown on issuers eventually could deal a serious blow to issuers' revenues. CP