The final provisions of the Credit CARD Act take effect in August, but issuers are still in the dark about several key requirements that will affect how they calculate penalty fees.
Under the law, fees for late payments, exceeding credit limits and other transgressions must be "reasonable and proportional," but the Federal Reserve Board has yet to issue final rules interpreting those terms. The draft policies that the Fed released in March have generated plenty of criticism from banks, which say the proposed rules would severely hurt their card-issuing operations.
"What's going on right now is we don't have final rules, and yet we have two pretty significant changes that are going to be going into effect," said Kathryn Kling, a partner who handles payments litigation with the Nelson Mullins Riley & Scarborough LLP law firm in Washington.
"It's really hard to be" prepared "until you know what you're getting ready for," Kling said.
Because the Fed has not issued its final rules, several major issuers declined to comment for this article, including JPMorgan Chase & Co., Citigroup Inc., Wells Fargo & Co., Capital One Financial Corp. and American Express Co.
But in public comments submitted to the Fed in response to its proposed rules, several expressed concerns about fee limits and strongly disagreed with proposals that would prohibit them from incorporating the cost of chargeoffs and other losses into their fee calculations.
Charging penalty fees "to customers who do not comply with the credit agreement enables us to approve credit for certain credit segments who may not otherwise generate enough revenue to offset their risk," Kurt Grossheim, president of GE Money Bank, a division of General Electric Co., wrote in an April 14 letter. "Reducing late-payment fees would prevent us from offering those accounts and result in lower credit availability among customer segments that need it most."
Besides requiring that penalties be "reasonable," the CARD Act provisions that take effect Aug. 22 also prohibit issuers from assessing penalty fees that exceed the amount that results in a violation.
For example, the Fed's proposed rules, published March 15 in the Federal Register, say that people who exceed their credit limits by $5 could not be charged an "over-the-limit fee" exceeding $5.
The rules also require issuers to perform account reviews every six months for cardholders who have incurred annual percentage rate increases to determine if the rate should be reduced.
The Fed has proposed three models issuers can use to determine if their fees are "reasonable and proportional."
One method is based on the costs that issuers face as a result of violations, including costs associated with collection, notifying consumers of delinquencies and establishing workout plans. Costs resulting from funding loss reserves and chargeoffs could not be used to determine this amount, which many issuers oppose.
"It really comes down to more subsidization," said Nessa Feddis, the American Bankers Association's vice president and senior counsel for regulatory compliance. "Do people who are more likely to pay late and therefore cause a loss — should they pay more or should others cover that cost?"
A second method would allow users to set penalty fees to deter violations of cardholder agreements. This method would require issuers to "use an empirically derived, demonstrably and statistically sound model that reasonably estimates the effect of the amount of the fee on the frequency of violations," the proposed rules state. Such a model must determine that "the imposition of a lower fee amount would result in a substantial increase in the frequency of that type of violation."
Both methods require issuers to reevaluate fees every 12 months.
In public comments, some issuers said the calculations for these methods would be too burdensome, which is why industry executives are eagerly awaiting the details on the third approach, a safe-harbor provision that would set a single penalty amount creditors could adopt as an alternative.
"I suspect many issuers will at least initially to be inclined to follow the safe-harbor fee amount until they get a better handle on what their actual costs are associated with a particular violation," said Duncan Douglass, a partner who specializes in payments with the Alston & Bird LLP law firm.