Credit card issuers this week began scrambling to formulate models for what they consider to be “reasonable and proportional” customer penalty fees for late payments and overlimit charges. They must submit their penalty fee models within a month to the Federal Reserve Board, which intends to use the information when it sets final rules implementing the last portion of the Credit Card Accountability, Responsibility and Disclosure Act.

While the majority of the Fed’s proposed rules, announced March 3, were not surprising, one unexpected twist was the Fed’s decision to put the burden on issuers to determine appropriate penalty amounts in various circumstances. Given the Fed’s relatively short deadline to respond, issuers must act swiftly to address an area that potentially could have far-reaching effects on their profits, analysts say.

“Issuers will need to spend a lot of time digesting the proposed requirements,” Duncan Douglass, an Atlanta-based attorney with Alston & Bird LLP specializing in the credit card industry, tells PaymentsSource. “In particular, the rules relating to reasonable and proportional penalty fees will require some fairly complex analysis by issuers.”

Major issuers PaymentsSource contacted said they are analyzing the proposed rules and preparing their responses, but they would not offer specifics. Issuers contacted include JPMorgan Chase & Co., Bank of America Corp. and Discover Financial Services.

The Fed’s proposed rules would prohibit issuers from charging penalty fees that exceed the dollar amount triggering the violation for late payments and purchases over the credit limit. For example, issuers no longer could charge a $39 penalty fee when a cardholder is late making a $20 minimum payment.

Issuers also are barred from charging fees for account inactivity, or charging multiple penalty fees on a single late payment or other violation of account terms.

The biggest challenge for issuers in the Fed’s proposed rules is that the Fed says it does not have sufficient information to determine penalty-fee amounts, so it is requesting issuers and others to submit data to determine fee amounts appropriate to cover issuers’ costs and to deter consumer violations. Issuers must submit their comments within 30 days after the Fed’s proposed rules appear in the Federal Register.

The final rules, the third and last set of regulations dictated by the CARD Act President Obama signed into law last May, are slated to go into effect on Aug. 22.

Under the proposed rules, issuers’ penalty fees will have to comply with a “safe harbor” the Fed plans to establish in its final rules that will be the greater of 5% of the minimum payment due or the overdrawn amount up to a cap the Fed will determine and a fixed amount based in part on issuers’ comments during the next month.

The penalty fees the Fed finalizes likely will put downward pressure on bankcard profits while cutting even more deeply into private-label retail card issuers’ earnings, analysts say. Penalty fees represent a greater share of profits for private-label card issuers than for bankcard issuers, according to Moody’s Investors Service Inc.

“Compliance with these rules will result in a significant reduction in fee revenue for many card issuers,” Douglass says.

Some consumer advocates are unhappy with aspects of the Fed’s proposed penalty-fee rules.

“The proposed rules contain a lot of unknowns,” Nick Bourke, project manager of the Pew Safe Credit Cards Project for the Washington, D.C.-based Pew Charitable Trusts, tells PaymentsSource. “While the Fed has laid out a process for issuers to establish reasonable penalty fees, they did not establish a firm cap on fees. So ultimately we don’t know how high penalty fees could go.”

Bourke fears issuers will seize the comment period to argue for higher fees. “Issuers have a big opportunity here to give all kinds of data to the Fed arguing what the safe harbor for penalty fees should be, and the Fed has indicated a willingness to listen to that. We wish instead that the Fed had defined what they mean by ‘proportional’ instead of leaving that up to issuers,” he says.

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