Consistent with the current government focus on enhancing consumer protection, the Credit Card Accountability Responsibility and Disclosure Act of 2009 (Credit CARD Act of 2009) brings sea changes to the credit card industry. Forward-looking financial services institutions are viewing these shifts not as a reactive compliance and operational exercise, but more broadly in anticipation of additional regulatory change. These firms are approaching the situation as a call to examine and improve businesses processes across the enterprise while considering the future business model for credit card lending as a whole.
Editors Note: This guest post was written by Michael Patterson and Amy Brachio. Michael Patterson is a principal and Amy Brachio is a partner in the Financial Services Office of Ernst & Young LLP.
This is a time of unprecedented challenges for the US credit card industry. Already grappling with a weak economy and a highly-stressed consumer credit environment, credit card issuers must also scramble to deal with public and legislative headwinds. A major challenge includes the new stringent guidelines of the Credit CARD Act of 2009.
Make no mistake: the Act will fundamentally change the way that a company does business across the entire credit card lifecycle. It also heralds the beginning of a stronger approach to rule-making and enforcement by regulators that will likely be extended to institutions’ other practices and products. This phenomenon is evident through “Financial Regulatory Reform: A New Foundation” from the Department of Treasury, in which a new Consumer Financial Protection Agency is proposed and the Credit CARD Act of 2009 is put forth as an example for future consumer protection regulations.
Against this backdrop, institutions must adjust their business models and related project planning must be multidisciplinary, clearly specified and comprehensively tested. To ensure the success of such a complex project, it is vital that organizations ensure seats at the table for compliance, operations and audit functions alongside senior management.
How we got here
Throughout the financial services sector, the economic crisis has exposed risky business practices and financial products that caused losses for institutions and individuals. Further, the deteriorating credit market, increased pressure to address controversial practices and louder calls from politicians for stricter regulations has led to the Credit CARD Act of 2009. The Credit CARD Act reaches far beyond the preceding Unfair or Deceptive Acts or Practices (UDAP) rules with changes including:
- An advancement of the effective date for many provisions included in the December 2008 UDAP rules from 12 months to 9 months, with some due in as early as 90 days.
- A restatement of the December 2008 UDAP rules concerning double-cycle billing, default/penalty pricing, credit line-related limits on financing of membership/application fees, restrictions on interest-rate increases and payment hierarchy rules.
- Additional provisions (related to gift cards and college/young customer marketing, for example) and calls for formal Federal studies into specific industry practices — potentially with a view to further regulation.
Where we are headed: secular change
As the regulatory model shifts toward greater proscription and more aggressive enforcement, the US card and consumer finance industry will be reshaped. Under the new regulations, companies will find it extremely difficult to be as proactively risk-sensitive (when it comes to increasing interest rates in the face of negative cardholder behavior) and fee and marketing restrictions will have a material negative impact on revenue streams. Consequently, issuers are focused on developing strategies to manage the future realities of a new operating model, including mitigating revenue loss from the restriction of certain fees, limitations on ability to re-price for risk and the need to compete for well-qualified customers.
Devising an action plan
Faced with tightened and accelerated regulation, the prospect of a significantly different competitive landscape and more regulatory oversight, it is imperative for companies to assure that compliance, operations and audit functions liaise with senior management within business units. This is especially important given that the Credit CARD Act of 2009 will have an impact on every part of the card lifecycle — from marketing and credit policy right through to billing and payments.
Further, issuers need to keep in mind that when making operational changes there is interplay between economics and compliance. Each time a change is made to a revenue stream or a product is modified, it is important to test the effect on profitability and market share. Decisions must be made with an understanding of the relationship between regulatory compliance and lost revenue as well as the potential impact on the brand’s reputation among consumers.
For a number of institutions, a broad array of processes and systems will need to be updated, which could represent a huge challenge. And many are already suffering from resource constraints because of the current economic environment, increasing delinquencies, shrinking consumer spending, significant organizational changes and, of course, decreasing profitability. At this moment, thoughtful project management is absolutely necessary and needs to include essential steps, such as:
- Creating an inventory: Understand the affected products, processes and practices.
- Conducting an economic impact assessment: Determine the profitability impact of prohibited practices and increased risk exposure for which you can no longer re-price.
- Assess the true costs associated with current fees: Analyze the fully loaded processing costs associated with negative customer behaviors to rationalize and potentially defend fee levels as being “reasonable and proportional.”
- Review other means to limit risk for which you cannot re-price: Look at line reduction programs and more restrictive acceptance criteria (staying mindful of equal credit opportunity obligations and appearances)
- Exploring strategies to replace lost revenue: Consider what might work best given an institution’s client base (e.g., higher interest rates, a uniform annual fee policy, cross-selling or other options).
- Devising a project plan: In order to meet the accelerated deadlines, it is crucial that the timeline for necessary changes to such areas as technology, policies, procedures, disclosures and marketing be clearly and carefully specified and tested.
- Implementing and testing: Make sure to allow adequate time to rigorously test and refine where necessary.
- Consider the broader implications of the new law and regulations: In anticipation of the law’s required “reports to Congress” on enforcement and other issues (e.g., interchange fee levels), and the potential further extension of the regulations’ logic (particularly broader application of UDAP), an assessment of additional product and practices regulatory and reputational exposure is mandatory to stay ahead of the regulatory curve.
Given the complexity and scope of the Credit CARD Act of 2009 and the complicated structures of the companies affected, it is difficult to grasp the significance of one particular stipulation out of a collection of inter-related provisions. That being said, we believe that it is important to highlight a few priorities. In addition to the short-term requirement for enhanced disclosures, the Credit CARD Act of 2009 contains provisions aimed at tackling asymmetric, factor-based decision making. Card companies have traditionally moved to increase a cardholder’s annual percentage rate (APR) when his or her FICO score (or another relevant factor) decreases, but far less often have readjusted the increased APR back when a FICO score rises or improved behavior warrants. Card companies will need to have processes and systems in place to periodically monitor and reassess actions taken due to changes in FICO scores and other key factors.
There are other aspects of the new guidelines that at first glance may seem rather nebulous by comparison, but are still important to consider. For example, penalty fees need to be “reasonable and proportional” and the Federal Reserve will soon have to issue rules that will specify a level of credit card penalty fees under which card companies will have safe harbor from challenge. The industry and individual institutions should rationalize and refine penalty calculation methodologies so that transparency and intellectual rigor are manifest.
Similarly, one of the proposed regulatory studies under the Credit CARD Act of 2009 concerns industry practice around limit reductions and rate increases that are based on transaction-level data. The study would seek to ascertain if such decision making is potentially discriminatory. Individual businesses need to concurrently examine their own existing policies in anticipation of increased scrutiny of their practices, including the consideration of reputational risks of using prudent but politically unpopular factors.
Planning for the Future
Given the systemic changes now confronting credit card companies, forward-looking firms are becoming proactive. These companies are anticipating broader, more subjective regulatory interpretations, future rule making and the reputational exposures associated with their products and practices. Some are taking advantage of this opportunity to improve their business processes. Dealing with the Credit CARD Act of 2009 will require improved internal lines of communication, an enhanced ability to execute change and closely examine product sets and execution of much-needed re-assessments of the way business is conducted. Rather than viewing this shift as a massive, rule-specific compliance exercise, these projects should be seen as a strategic and holistic effort to favorably position an institution as the global economy improves.
This guest post was authored by Michael Patterson, a principal, and Amy Brachio, a partner, in the Financial Services Office of Ernst & Young LLP. Michael can be reached at +1 212 773 2824 or michael.patterson1 [at] ey.com. Amy can be reached at +1 202 327 7552 or amy.brachio [at] ey.com. The views expressed herein are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or Glenbrook Partners, LLC.
- Payments News: Sen. Chris Dodd Introduces Major Reform of Credit Card Practices
- WhiteHouse.gov: Fact Sheet: Reforms to Protect American Credit Card Holders