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Credit Card
Creative Commons License photo credit: barsen

A credit card industry insider recently made an interesting argument that it is.

If you remember, Bank of America pledged on Oct. 6 to stop raising interest rates, then turned around and announced it would start adding annual fees to some customer accounts next year (although from the mail I get, some customers have already been told their accounts will be subject to the fees).

Odysseas Papadimitriou, formerly of Capital One and now CEO of CardHub.com, argued at WalletBlog.com that under laws regulating credit cards, fees and interest rates are considered essentially the same thing. (You can trace this to the 1996 Supreme Court case Smiley v. Citibank.) He calls Bank of America’s actions a marketing bait and switch, and says if the bank proceeds with its plan to implement annual fees it will in effect be raising the costs on existing balances–something that’s prohibited under the credit card reform act now scheduled to go into effect next year.

Papadimitriou points to Chase’s aborted plans to add “inactivity” fees to low-rate balance transfer accounts as another example of promise breaking.

What I’m reminded of, though, is all the times in the past when issuers tried to foist stupid fees on its customers–inactivity fees and fees for not carrying a balance being two of the most egregious examples from the 1990s.

The savviest users always bolted and issuers had to back down. The fees that remained–late fees and overlimit fees, in particular–were mostly paid by the less-savvy consumers.

An issuer that drives away all its smart, credit-worthy customers won’t be in business for long. Previous generations of credit card executives had to learn this lesson the hard way. Looks like the current generation will, too.

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7 Comments

1

This is a really interesting debate. I’m going to link this post to bankinnovation.net. I’m curious to see how it unfolds.

2

Me, too. I’m not quite clear that membership fees are included in the fees treated as interest equivalents by federal regulation, but if they are this could shape up to be an interesting fight with regulators.

3

Let’s leave the issue of the legality of fees as interest equivalents alone for a moment, and explore why anyone is shocked that banks are scrambling to find other methods of generating a profit.

Our legislators have arbitrarily determined that the previous set of rules were insufficient to protect consumers from being charged too much interest (insert annual fees, ODP charges, or any other revenue equivalent item). They have altered the bank’s ability to make a profit, a shareholder’s ability to earn a return, and even the customer’s ability to get a credit card.

Why are we surprised that banks will use this time to identify and implement ways to allow them to still make a profit? Or that shareholders of the bank still expect a return based on revenue and profit growth? Or that displaced customers seeking credit will find other lending alternatives that charge every bit as much as the bank (or more.)

If the government decided that your income was no longer earned fairly, and that effective some months from now you could no longer collect the same level of pay for what you did, how would you react?

Wouldn’t you be as energetic as possible, seek every immediate way to maximize your earning potential until that day — and then try to convince your spouse that making less was really OK? I suspect that you’d do some foolish things like the banks have, and in the end, learn to adjust.

Why is anyone surprised, or angry, that when the legislature takes away your ability to earn a profit, organizations seek alternatives that may test the new boundaries of legality or common sense?

4

The credit card reform act hardly took away lenders’ ability to make a profit. What it did do, combined with the credit crunch, is make it harder for issuers to earn the kinds of record profits they made in the recent past.

5

In aggregate, you make a good point. Against the specific segments of higher risk credit card customers that can no longer be effectively priced for their risk, I’m sorry, you’re wrong.

As a result of the CARD Act, banks are now “stuck” with segments of higher risk customers that will not be profitable. The mass of better risk customers will have to subsidize their cost to allow the bank to make a profit in this business.

Until the higher risk population can be reduced as a proportion of the bank’s overall credit business, everyone’s prices for credit will go up.

And customers that used to be able to get credit from banks, will no longer have this option. While they might be “less savvy” they are still adults with a right to their own decisions – And they will find other less regulated sources of credit.

The result of the CARD Act is that fewer people will have access to regulated credit sources. Not that customers will have better prices.

6

I’d like to offer an answer to the question that Bill posed: “If the government decided that your income was no longer earned fairly, and that effective some months from now you could no longer collect the same level of pay for what you did, how would you react?”

My answer: if I had earned that extra money from deceptive, unethical and borderline fraudulent business activities, I’d probably shrug my shoulders and take my medicine.

Bill seems to have a skewed idea about what the CARD Act actually does. It places no limits on the interest rates that banks can charge, nor does it force them to keep on customers they don’t want, and thus his claim about banks being “stuck” with unprofitable higher risk customers doesn’t hold water. The CARD Act merely ends a number of egregious and sleazy business practices, and forces issuers to actually abide by the terms they offer to their customers.

Among the practices ended by the act are arbitrary interest rate increases on existing balances, universal default, no-notice rate increases, double-cycle billing, due date gimmicks, use of misleading terms in a contract, abuse of over-the-limit fees, unfair allocation of payments (i.e., allocating a payment to the lowest-rate debt first), and predatory practices with respect to fees on subprime cards.

Again, it does not cap interest rates and it does not limit when rates can be increased on future balances. So you’ll forgive me if I don’t shed any tears for these poor beleaguered banks who are only trying to make an “honest dollar”.

7

Thanks for the thoughtful response, Andy.

It’s not entirely analogous, but I’ve heard similar arguments from rogue debt collectors and telemarketers (particularly right before Congress passed the Do Not Call legislation)–essentially, that regulations on what they do would cost them money or even their livelihoods and for that reason shouldn’t be enacted. While I agree we shouldn’t strangle business with unnecessary regulation, I don’t think Congress has any obligation to ensure or preserve the profit margins of the past.