Statement submitted by the Board of Governors of the Federal Reserve System to the Subcommittee on Consumer Credit and Insurance of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, February 9, 1994.
The Board of Governors of the Federal Reserve System appreciates the opportunity to comment on the credit and charge card legislation being considered in H.R.1842 and H.R.2175. Because this legislation is driven, in part, by concerns about the level of credit card rates, we thought it would be useful to the subcommittee to have some current background on this issue.
RECENT DEVELOPMENTS IN CREDIT CARD PRICING
Credit card lending is a competitive market that consists of many thousands of card issuers, all free to establish their own prices and other lending terms. The credit card market has changed significantly over the past few years. Competition, which was keen during the 1980s, has grown more intense as new firms have entered the market and challenged established card issuers by aggressively pricing their credit card products. While competition in the 1980s focused on efforts to broaden customer bases by increasing the availability of cards to higher risk groups and by offering additional product enhancements, this focus has shifted to efforts to retain and broaden customer bases by offering more favorable interest rates, waivers of annual fees, and, in some larger programs, rebates of various types.
To better understand credit card pricing behavior, it is useful to compare credit card lending with other types of bank loans. Generally, credit card lending is riskier than other types of bank lending because it is unsecured and card holders may choose to use their cards when they are under the most financial distress. Consequently, a relatively large "risk premium" is built into the pricing structure of credit card plans. A second prominent feature of credit card lending is that the cost of funds, while an important component of total costs, makes up a relatively small percentage of total lending costs compared with other types of bank lending. Because funding costs are a smaller component of total costs for credit card lending, changes in the cost of funds are more likely to be offset by movements in other cost components. A third major factor that differentiates credit card lending from other types of bank lending is that the interest earned on credit card balances is substantially less than the stated rate might suggest because convenience users (those who pay their balances in full each month) generate little or no revenue from finance charges.
After many years of relative stability, credit card interest rates recently have fallen sharply. An unusually steep and sustained decline in the cost of funds to issuers and the lingering effects of the last recession, which saw outstanding balances on credit cards grow at a much reduced pace, have exerted downward pressure on credit card interest rates. In addition, the elevated default rates and substantial credit losses stemming from the past recession appear to have fundamentally influenced the pricing behavior of many card issuers, including a number of the largest issuers in the country. Although credit card issuers in the past tended to offer a basic plan with one rate for all customers regardless of risk and account activity level, some of the largest issuers have now lowered rates for card holders who have good payment records and charge large amounts. Higher interest rates are still applied, however, to higher-risk customers: those who have a record of not paying their bills on time.
Contributing to the growing interest rate competition may be an increasing sensitivity by consumers to credit card rates, perhaps because of the difficult times that many encountered during the last recession and the heightened publicity about the high rates of interest on credit cards. Another factor that may be causing a decrease in credit card rates is the increased difficulty card issuers have encountered in acquiring new customers in a relatively mature market. The high cost of attracting new customers in a competitive, mature market places a premium on retaining existing customers, particularly on those who charge large volumes and revolve substantial balances. Reducing rates and waiving annual fees is one way to curtail attrition. A further indication of growing interest rate competition is the aggressive marketing of rollover balance programs that offer attractive rates to card holders who roll their outstanding debt into a new card issuer's plan.
Evidence of the changing nature of competition in the credit card market can be found in the Federal Reserve's series on credit card interest rates published in its G. 19 statistical release. This data series shows the average rate charged by a sample of credit card issuers for their largest credit card plans. From the end of 1981 through the beginning of 1991 this average credit card interest rate varied only a little and averaged more than 18 percent. Beginning in early 1991, however, it began a steady decline that has continued to date. In February 1991, the average interest rate on credit cards as measured by our survey was 18.28 percent. Our latest survey, for November 1993, indicates the average rate had fallen to 16.30 percent.
A second survey of credit card interest rates conducted by the Federal Reserve also reveals the decline in interest rates. Twice a year, the Board produces a report entitled Report on the Terms of Credit Card Plans, which shows the terms offered by about 150 of the largest credit card issuers for their largest credit card plan. This report is made available to the public without charge as a tool to assist them in comparing the various features and costs of alternative credit card programs.
This report on credit card terms was first made available in March 1990. At that time, 10 percent of the issuers offered plans with interest rates of less than 16 percent, and only two issuers had plans with rates of less than 14 percent. Our most recent survey, released in September 1993, reveals a dramatic change; 41 percent of the issuers offered a rate of less than 16 percent on their largest plan, and 14 percent had rates of less than 14 percent. Eight of the 153 issuers charged a rate of 12 percent or less on their largest plan. A copy of the report is attached to this statement.(1)
CREDIT CARD PROFITABILITY
The Fair Credit and Charge Card Disclosure Act directs the Federal Reserve to report to the Congress annually about the profitability of credit card operations of depository institutions. The most recent report was submitted in September 1993. Information for this report is drawn from two surveys: the Functional Cost Analysis conducted by the Federal Reserve Banks and the Report of Condition and Income. The report indicates that in recent years credit card profitability has generally been higher than returns on other major bank product lines, although net earnings as a percentage of outstanding balances for credit card banks in 1992 were not as high as they were in the mid-1980s. The most recent data from the Report of Condition and Income continue to indicate that credit card earnings are strong.
With this as background, we have the following comments on the specific legislation.
H.R. 1842 would amend the Truth in Lending Act to provide for additional disclosures relating to credit and charge card accounts. For example, the bill would expand disclosure requirements for applications and solicitations mailed to consumers and for card account advertisements. The bill would also provide consumers with substantive rights, along with additional disclosures, when card issuers initiate certain changes in terms of card accounts. H.R.1842 would also impose limitations on card issuers' ability to use information about customers for direct marketing purposes and restrict their ability to assess finance charges before credit extensions are posted to the account. Finally, the bill would require that the Comptroller General of the United States, in consultation with the Board, conduct a study of competitiveness of the credit card market.
The Board believes consumers benefit substantially from Truth in Lending disclosures that permit them to compare and evaluate credit card plans. For example, early disclosures already required by the Fair Credit and Charge Card Disclosure Act enable consumers to consider rate and other cost information before they apply for a credit card account. Taken individually, each of the bill's required disclosures, set forth in a standardized tabular format, may additionally assist consumers in their comparison shopping before they become obligated or in their evaluation of an existing account. Consumers, however, already receive many of the disclosures required by the bill--such as basic cost information in the table and notices of changed terms-- under the current Truth in Lending scheme. The Board believes that existing law supplies consumers with adequate information about the key costs associated with credit and charge card accounts. We are concerned that by "layering" essentially identical disclosures the effectiveness of the current scheme may be diluted if consumers find the duplicate disclosures to be confusing.
Disclosures on Envelopes
For example, H.R.1842 would require that the disclosure table appear on envelopes containing card applications or preapproved solicitations mailed to consumers in addition to the disclosures already required with the application or solicitation inside. We are also aware that consumers receive in the mail offers for card accounts enclosed in envelopes that may boldly display a term such as an introductory low annual fee or annual percentage rate. Nonetheless, the Board believes that the proposed requirement would not offer enough benefit to consumers to further complicate the rules. The consumer who is intrigued by a card issuer's offer to open an account will of necessity have to open the envelope to act on the offer and at that time will encounter the current disclosure table. The consumer who chooses not to open the envelope is not interested enough to consider the offer (and see the disclosure table) and has not been misled by the card issuer's marketing. The table currently required plays an effective role in connection with applications or preapproved solicitations by providing basic information in a user-friendly format to consumers as they complete the application form. The Board believes a second table on the envelope is unnecessary.
Additional Disclosures in the Table
The Board believes that caution should be exercised in mandating additional disclosures in the table. For example, information about the terms and conditions for forfeiting a grace period may be lengthy and detailed and could complicate the box and detract from its current "clean" appearance. On the other hand, adding the annual percentage rate for cash advances could be very useful for consumers.(2)
Changes in Terms
The Board is also concerned about the potential for consumer "information overload" when card issuers change certain account terms and about excessive cost and regulation. Currently, card issuers initiating changes adverse to consumers are generally required to send notices that highlight the changes at least fifteen days in advance of the change. The bill would require that the new terms to be set forth in a tabular format on at least one periodic billing statement before the effective date of the change. The bill would also require that a description of certain changed terms be provided in a tabular format on a separate piece of paper that is enclosed with a periodic statement sent at least thirty days before the change. Finally, the envelope containing the separate description and periodic statement must display a statement alerting the consumer to the fact that contract terms have been changed and that details are available inside.
The Board recognizes that a brief notice on an envelope stating that changes in contract terms are contained inside may be meaningful to consumers in the same way an envelope bearing the notice "Tax information enclosed" distinguishes for taxpayers the significance of the contents of that correspondence from others.
The Board is concerned, however, about the potential for consumer confusion if the bill's proposed disclosure scheme were added to the existing law regarding changed terms for card accounts. Read as a whole, the bill provides that consumers whose credit card plan is about to change would receive a periodic statement that reflects the terms in effect for the billing period covered by the statement. The same statement would also contain the prospective terms set forth in a table along with the other disclosures that remain unchanged, although the bill does not require that the new terms be distinguished from others not affected by the change. The consumer would also receive a separate document that describes in tabular format the changed term.
The Board believes the current disclosure scheme--requiring changed terms to be highlighted in some way--is adequate and straight-forward. Requiring a periodic statement reflecting the terms in effect for the previous billing period as well as a disclosure table applicable to future periods seems potentially confusing, and the inclusion of a tabular description of the new term--while highlighting the change--seems repetitive in combination with the disclosure table contained on the accompanying periodic statement.
H.R.1482 would expand the Truth in Lending disclosures required for credit and charge card advertising. Currently, mentioning specific costs in advertisements for credit card plans triggers a card issuer's duty to disclose other cost information. For example, a card issuer that advertises its annual percentage rate must also disclose any minimum finance charge, transaction fee, or other charge. The Board by regulation also requires that annual fees be disclosed. Advertising "low" annual percentage rates or "no transaction fees" does not trigger the requirement to state additional cost information about the card account.
The bill would mandate that the table disclosures now required for applications and solicitations be disclosed on any advertisement that promotes card accounts. The disclosure requirements would differ, depending on the medium in which the card advertisement is promoted (radio, television, or print).
The Board appreciates the concern that general advertisements may not provide full disclosure of important credit terms. However, the Board believes that mandating cost information for all advertisements may, in fact, create a disincentive for advertising rather than an incentive for more disclosure. The Board believes that the current disclosure scheme for advertising accounts provides adequate information to consumers who are shopping for credit cards. If specific cost information is advertised, a uniform disclosure of credit terms is required. Card issuers that aggressively market through direct mail or telephone campaigns must already comply with the more detailed disclosure requirements of the Fair Credit and Charge Card Disclosure Act. In addition, consumers are provided with complete Truth in Lending disclosures before they become obligated on the plan, and the Board by regulation has provided that if consumers are not given full disclosures beforehand, a consumer may reject the plan once disclosures are received (and any membership fee paid must be refunded).
Finally, although the clear and straightforward approach of the proposed table may be more easily comprehensible on a television screen than lengthy narrative disclosures, the Board notes the difficulties in assuring meaningful disclosures in electronic media such as television.
If the Congress determines to go forward with legislation to amend the advertising rules for credit card plans, the Board notes that the proposed bill contains an exception for advertisements that are "solely promotional and do not solicit business." The distinction seems vague, and we urge the Congress to clarify the intended scope of the exception to the disclosure requirements for credit card advertisements.
H.R.1482 would also require that card issuers disclose information not currently mandated by law. For example, card issuers would be required to provide on each periodic statement cumulative year-to-date data on the total amount of payments made and finance charges paid. The bill would also require that card issuers include on the first three statements provided in a year the information--set forth in a tabular format that identifies various fees and charges paid during the previous year. While the disclosures would provide figures that some consumers may not otherwise calculate, the Board remains concerned about the need for repetitive disclosures. Also, the Board questions the need to mandate year-end figures because it is aware, for example, that card issuers frequently provide consumers with information about the total finance charges paid during the previous year.
The bill would also require that periodic statements disclose a date that reflects when the current outstanding balance would be paid off if the consumer chooses to pay only the minimum periodic payment required under the plan. A "snapshot" view of the potential length of the consumer's obligation is information that undoubtedly could be interesting to some consumers and would provide useful information that consumers might use in evaluating their credit practices. However, the Board would note that to reduce the potential length of the obligation, card issuers might raise minimum payment amounts or reduce credit limits, which may be detrimental to consumers.
H.R. 1842 would provide three substantive rights to consumers by amending the Truth in Lending law. The bill would permit consumers to cancel a card account and pay off any outstanding balance under existing terms when certain changes in terms occur (for example, an annual percentage rate increase). The bill would also permit a consumer to limit a card issuer's ability to use information about the consumer for direct marketing purposes. Finally, the bill would provide that finance charges for extensions of credit can begin only from the date the extension is posted to the account. Although the Truth in Lending Act includes some substantive provisions, it remains primarily a disclosure statute. The Board continues to believe that substantive laws should generally be left to the realm of state law.
Regarding the provision that gives consumers the right to pay off existing balances on the terms in effect at the time of a change in terms, the Board notes that some states have in fact legislated in this area.
The Truth in Lending Act requires that card issuers identify on periodic statements credit transactions occurring during the statement period, and the Board by regulation authorizes card issuers to identify credit extensions by the date of the transaction or the date the transaction is posted to the consumer's account. The policy reason for mandating a delay in the imposition of finance charges from the date of the credit extension to the date of posting is unclear because the consumer received the benefit of the credit extension on the earlier date.
H.R. 1842 would require that the Board maintain a toll-free number for consumers to call for information on the availability of low-rate credit cards. Although the Board endorses the desire to enhance consumer awareness about credit card interest rates, it does not believe that it is appropriate for the Board to endorse any particular card program for consumers. Currently, the Board produces a credit card shoppers guide that is made readily available to consumers free of charge. In addition to rate and fee information, the guide includes the telephone number of card issuers for consumers to call to apply for a card; many of those numbers are toll-free. The Board maintains a mailing list and distributes the guide to libraries nationwide. In addition, lists of rates and other fees offered by card issuers are now readily available to consumers from groups such as Bankcard Holders of America and from commercial sources.
H.R. 1842 calls for a study of the credit card market by the Comptroller General of the United States (GAO), in consultation with the Federal Reserve Board. Such a study has already been conducted by the GAO and has recently been submitted to the Board for comment.
The major credit card issuers generally impose a fee on merchants that honor credit cards and at the same time prohibit merchants from directly passing that charge on to cardholders. This prohibition currently applies as well to government agencies that honor credit cards for payment of such items as auto registration fees and state property taxes. H.R.2175 would bar card issuers from applying this prohibition to government agencies and thus would enable the agencies to directly pass on the fee to consumers.
Merchants may absorb the costs of the fee by adjusting the pricing of goods or services. To recover costs, government agencies would have to increase fees or raise taxes. And some state and local laws may prohibit or restrict public agencies from absorbing this cost. By allowing government agencies to pass the costs of credit transactions directly on to consumers, H.R.2175 could increase public use of a more convenient payment option. On the other hand, it would also create different rules for the private and public sectors.
1. The attachment to this statement is available from Publications Services, Board of Governors of the Federal Reserve System, Washington, DC 20551.
2. Indeed, when originally promulgating rules for the Fair Credit and Charge Card Disclosure Act, the Board proposed to add such a disclosure. Upon further analysis, after a review of comments that objected overwhelmingly to any additional required disclosures in the table, particularly to one that did not relate to purchases, the Board withdrew the proposal because it was not required by the statute.
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|Publication:||Federal Reserve Bulletin|
|Date:||Apr 1, 1994|
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