Responding to an outcry from consumers, in 2009 Congress overhauled the rules for credit-card companies. The bipartisan CARD Act ended some questionable—and lucrative—bank practices, like charging hidden fees and offering low introductory interest rates only to jack them up suddenly. The industry hated the reforms and issued dire predictions that they’d mean the end of plastic.
Three years later, card companies are sheepishly, if quietly, admitting that they’re seeing a surprising benefit from the conservative lending the law was designed to promote. “If there is a silver lining to the CARD Act—I’m not here to say the CARD Act was good for our business, so nobody misunderstand the comment—but if there were a silver lining to it, it forced rationality,” said Mark Graf, chief financial officer of Discover Financial Services, at an industry conference in May. Rationality means not giving credit cards to just anybody—especially those who’ve shown they’re at high risk of falling behind on their payments or defaulting. That seems obvious enough, yet it wasn’t the case when, as Graf put it, the credit industry was engaged in a “silly race to the bottom.”
Before the law, banks didn’t have to be as careful about picking customers. If a borrower missed payments, the lenders would raise his rates, cut his credit limit, and bury him in nuisance fees. That’s one way to manage risk and discourage bad behavior, but it’s hardly the most efficient, and it infuriated cardholders. The CARD Act outlawed that practice, so now companies must account for a customer’s likelihood of default before they issue the card. They can still offer low teaser rates, but they can only raise the permanent rate in limited cases, such as when the account is 60 days delinquent.
That’s helped reduce late payments to the lowest level on record. And so-called charge-offs, the debts lenders deem uncollectible, are at their lowest since the end of 2006. In May the industry identified $276 million in charges they assume won’t be paid, down from a peak of $821 million in August 2009.
Even stricter rules could be on the way. The Consumer Financial Protection Bureau is using its new powers under the Dodd-Frank financial reform law to monitor the credit-card industry and track customer grievances. On July 18 the bureau brought its first enforcement case, against Capital One. The company agreed to pay $210 million, including as much as $150 million in customer refunds, to settle complaints that the telemarketing companies it hired tricked customers into paying for a service that monitored their credit rating and other unnecessary add-ons. (The bank didn’t admit or deny wrongdoing.) The agency is pressing for a standard, two-page credit-card contract in plain English, free from the microscopic lawyer language where fees can be buried.
No surprise that the banks are against it. Nessa Feddis, vice president at the American Bankers Association, has written to the bureau saying the simplified disclosure form leaves out important information such as details about penalties. “It sounded like a good idea,” she says, “but it just doesn’t work as a matter of practice.”
If the CARD Act is any indication, lenders may not always feel that way. Sanjay Sakhrani, a credit-card analyst with Keefe, Bruyette & Woods who issued “outperform” ratings for Capital One, Discover, and American Express, says pushing credit-card companies to do something they didn’t want to do has helped the industry. The law “forced their hand to assume the worst-case scenario,” he says. “And the best-case scenario is playing out.”