Newsletter Archive

New credit card regulations could bring back the tight access and low limits of the '70s.

On May 22, President Obama signed a sweeping credit card reform act, The Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009. The new law severely limits how much banks can charge customers, no matter how much of a risk for default they pose. The new law is intended to make banks and credit companies play fair and protect cardholders against sneaky and unfair billing tactics when they choose to use credit cards. It requires expanded and clearer disclosure of card terms and creates new rules about when creditors can increase annual interest rates on existing balances. Most of the provisions go into effect February 22, 2010.

Why We Are Where We Are
There are generally misconceptions about the credit card business that have lingered for 20 plus years.  Bank and Card companies did not dispel the misconceptions.  The demand was there and the issuers fulfilled it.

Card loans are unsecured loans and these loans typically have higher rates due to risk.  In fact, in the ‘80’s, before the emergence of the very larger credit card issuers, card loans were priced around 18% with some store cards at over 20%.  Fees were low and not aggressively charged.  Annual fees were also common.

Consumers loved the product.  In some cases they received a free loan for 60 days.  They had a choice to pay off or pay a little.  Cards were a great convenience.  Cash was irrelevant.

As major banks and independent issuers entered the market, competition became fierce.  Rate wars began.  Annual fees became rare.  Issuers built new system capabilities for promo rates and balance transfers.  Rewards were added.  Now, consumers not only had convenience, but also low rates and benefits.

Issuers countered with risk-based pricing for customers with default type behavior.  They also raised penalty fee amounts and assessed them more aggressively.  Some consumers were now faced with higher rates and fees, to which they were not accustomed.  Outrage began.  Consumers couldn’t understand why they weren’t receiving a late fees grace period of 15 days that they received on car loans and mortgages.  The more aggressive banks were with penalties, the more dissatisfaction occurred.  Consumer groups and legislators rallied for the consumers.

Banks were serving the needs of most customers by having competitive rates, offering rewards and other perks, but simultaneously they were assessing high rates and penalties to their riskier clients.

Systems were built to deliver promotional rates, balances transfers and rewards.  Penalties routines were added to programming.  Entire risk-based pricing models were designed.  

Impact of New Regs
Essentially, the new regs have made changes to card products more difficult and less quantitative for the issuer.  The ability to price for risk through penalty pricing rates has essentially been removed.  Rates cannot be increased until the account is 60 days delinquent, i.e., 3 missed payments.  At that point, issuers can raise rates, but only after a 45-day notice.  This is essentially 60-days notice, since new rates can only begin in a new cycle.  The overwhelming majority of these accounts will be written off with the issuers not being able to recover any costs or losses.

Restrictions on fees will also significantly impact revenues for issuers.  Additionally, regulators will review fee amounts and the result of this review could also negatively affect revenues for issuers.  

There are also many administrative and communication changes required of issuers in the new regulations that will impact the cost of doing business.

Technology Impact
The industry will need to unwind what they have created over the years. The industry has created flexible solutions to support the competitive nature of the industry. With this pending implementation of regulations, it will take the flexibility and make them inflexible. Capital has been spent to develop these systems, now they will need to spend capital to unwind them and create new products and risk systems to support them. For example, dealing with the new rule that prohibits card issuers from charging over-limit fees if the cardholder exceeds a credit line. The rule requires that the cardholder first must agree to those transactions. Currently, that functionality does not exist today.

What Do Banks Have To Do
The current business model that issuers are using is likely to be replaced.  It is unlikely that issuers can make this model profitable.  Many smaller issuers with marginally profitable portfolios will look to sell their portfolios.  Some will cease offering the product and exit the business.

Major issuers have a number of choices.  One is that they can return to the 1980’s model with high rates, annual fees and no rewards.  This is a return to a one size fits all product with little regard for individual customer risk or customer benefits.  Hopefully, this model will not be a popular one.  Card issuers do not appear to be ones to simply settle for less profit.  They have always been innovative and progressive.

What is likely to happen is that issuers will need to design new card products that not only meet the rigorous regulatory requirements, but also provide customers with value.  For now, the cost of risk needs to be shared between high risk and low risk customers.  Hopefully banks can find models to properly compensate themselves without punishing their very good clients.

New thinking will be needed.  Innovation will drive the new card business.  It’s an exciting time for the business, but it means big changes.

The Three Main Points

1. The current model needs to be rebuilt.  There is little that issuers can do to retrieve the income that will be lost under the current model.  Attempts to do so will likely exacerbate the industry’s current position.

2. All aspects of the business should be re-examined.  The new regs affect many current operations, processes and decision-making practices.  Here are some examples:

• Application and fulfillment processes
• Systems’ designs, settings, parameters
• Credit decisions
• Overlimit practices
• Paying off old balances
• Subprime practices
• College students and under age policies
• Operations workflow, branches, payments
• Funding
• Marketing
• Communications
• Forms, documents

There are many more, and all of these require reviewing systems and processes.

3. Timing is critical - the amount of work to meet implementation deadlines cannot be underestimated.  Point 2 above shows the breath of the changes needed.  Issuers will need to dedicate teams to ensure compliance.  Penalties for non-compliance have increased.  Dedication to the many implementation requirements is unquestionable.

One last tip - issuers need to reconnect with customers and build trust.  It will be difficult, but they must get to the point where customers rely on banks and issuers as trusted advisors.  This will be a very long process and will be ongoing.