US regulators and banks go head-to-head

The US Federal Reserve has announced that it
will be clamping down on credit card fees under the Federal Trade
Commission Act. However, US banks are opposing the move, and it
remains to be seen whether these proposals will survive in their
current state. Truong Mellor reports.

US federal regulators are currently poised to
introduce new measures in an attempt to address penalty fees and
other credit card company practices that consumer groups have
labelled exorbitant and unethical. The proposed measures, released
for public comment under the Federal Trade Commission Act (FTC
Act), would protect consumers from unexpected increases in the rate
charged on pre-existing credit card balances, and would also
prohibit banks from imposing interest charges using the ‘two-cycle’
billing method, making sure that consumers receive a reasonable
amount of time to make their credit card payments.

These new rules would also prohibit the use of
payment allocation methods that unfairly maximise interest charges,
and include protections for customers that use overdraft services
offered by their bank.

“Consumers relying on cards should be better
able to predict how their decisions and actions will affect costs.
At present, this is not always the case,” said Federal Reserve
chairman Ben Bernanke in a statement to the press. “The proposed
rules are intended to establish a new baseline for fairness in how
credit card plans operate. Consumers relying on credit cards should
be better able to predict how their decisions and actions will
affect their costs.”

The Fed’s proposal under the FTC Act also seeks
to address practices in connection with a bank’s payment of
overdrafts on a deposit account, whether the overdraft is created
by cheque, a withdrawal at an automated teller machine, a debit
card purchase or other transactions. The proposal requires
institutions to provide consumers with notice and an opportunity to
opt out of the payment of overdrafts, before any overdraft fees or
charges may be imposed on their accounts. These provisions are part
of an ongoing effort on the part of the Fed to augment protection
for credit card users, and follow the 2007 proposal to improve
credit card disclosures under the Truth in Lending Act.

According to Randall Kroszner, a Federal
Reserve governor who chairs the Board’s Committee on Consumer and
Community Affairs, the Fed received more than 2,000 comment letters
from individual consumers regarding card issuer practices that were
characterised by some as “traps for the unwary”.

“If the rules are adopted, consumers may see
some costs decline as new business models emerge, while other costs
might increase. The intent is to increase transparency and fairness
in how credit card and deposit accounts operate, thereby enhancing
competition and empowering consumers to better manage their
accounts and avoid unnecessary costs,” said Kroszner.

To make sure that these protections apply to
consumers whose cards were obtained through savings associations
and federally-chartered credit unions, the Fed has been joined by
The Office of Thrift Supervision and the National Credit Union
Administration in drafting the proposals.

This initiative comes at a time when the US
Congress is considering its own plans to curtail some of the credit
card industry’s billing practices. In addition to the pressure
being applied regarding interchange fees (see CI 397 and Report
reignites US interchange issue), Senator Christopher Dodd, head of
the Banking Committee, has introduced legislative measures to ease
expensive credit card charges and to put a stop to unjustified rate
increases.

Consumer protection groups have long argued
that regulators need to act decisively to help the credit card
industry avoid a meltdown. There have been several red flags that
regulators in the US were quick to act upon. The level of credit
card loan delinquency has been steadily rising, and stood at a
national average of 1.36 percent in the fourth quarter of 2007, up
nearly a third from the previous period.

US consumers are increasingly using their
credit cards to pay for household necessities and to keep up with
mortgage payments, which is another telltale sign of financial
distress. In February 2008, consumer credit rose by $6.5 billion
according to the Fed. The figures for the following month brought
US consumer borrowing in the first quarter of 2008 to $34 billion,
its highest level since the first quarter of 2001.

Many of the banks and credit card companies
that will be affected by the proposed measures have spoken out
against them, calling the regulation an unwarranted and ultimately
fruitless intrusion into the marketplace. The argument these
institutions are making is that the new proposals will lead to
higher prices for the consumer and a curtailing of competition
within the industry.

It has also been suggested that these measures
will in fact reduce the availability of consumer credit at a time
when the Fed is committed to increasing access. The new regulations
would force some smaller banks to abandon their credit card
operations, creating a monopoly of larger institutions in control.
While it is difficult to assess the financial impact these
regulatory measures would have if they were to be adopted, one
potential outcome would be a widespread move towards individual
pricing within the cards industry.

“It may not reduce their profitability,” says
Gwenn Bezard, senior analyst at Aite Group, “but it may in fact
reduce the overall market opportunity for the banks and credit card
issuers. They may in fact focus on a smaller market and stay away
from subprime, but profitability may not be affected.”

In all likelihood, the financial institutions
in question will fiercely campaign to have these measures diluted
before they come into force. It should also be noted that banks and
credit card companies have proved to be incredibly resilient when
faced with challenges to their revenue streams – one only has to
compare the furore that surrounded the Gramm-Leach-Bliley Act
almost a decade ago to the relatively minimal financial impact it
had on them.