Five Years Later, CARD Act Impacts Grow Clearer

(New York, NY): The effects of the 2009 Credit CARD Act, the most comprehensive set of reforms ever imposed on the industry, have come into focus more than half a decade later, Auriemma Consulting Group said in comments to federal regulators.

Submitted in a letter to the Consumer Financial Protection Bureau (CFPB); the agency responsible for reviewing the law’s effectiveness every two years, the comments weigh consumer benefits generated by the CARD Act against a series of unintended consequences.

At a glance, the legislation has been a victory for consumers: credit card issuers have made sweeping changes to their practices since 2009, reducing fees, curbing interest rate hikes, and going above and beyond the law to make credit card agreements easier to understand. These changes have led to increased transparency in the credit card market, a goal shared by issuers and consumer advocates alike.

There is growing evidence however, that less desirable changes in the market—higher interest rates, reduced access to credit, and a shift away from borrowers with lower credit scores—are directly related to the Act’s principal reforms. Implemented throughout 2010, the recessionary cycle obscured the relationship between these reforms and market characteristics. Five years later, improving economic conditions have yet to yield commensurate improvements in either pricing or credit availability.

“While the CARD Act has produced clear consumer benefits in some areas, changes in market characteristics are difficult to ignore,” said Marc Sacher, Executive Vice President of Auriemma. “Pricing for one population is higher at the expense of another, just as access to credit has shifted from one population to another.”

Principal reforms include repricing restrictions that largely eliminate interest rate increases on credit card balances. Whilst such restrictions have clear outward benefits—upfront costs presented to applicants are more transparent—they leave issuers less able to manage credit risk, which tends to fluctuate over time. As a result, issuers must price to the level of risk the customer might reach over the life of the account, rather than reflect their current and historic behavior.

Prior to the CARD Act, it was common for issuers to adjust an interest rate in response to relevant credit information, including a cardholder’s repayment behavior. Today, this practice is permitted only in advanced stages of delinquency when a cardholder’s likelihood of default is significantly higher. Administrative barriers imposed by the law, including a requirement that issuers review accounts indefinitely following a rate increase, further discourage the practice.

“The CARD Act has changed the nature of risk management within the industry,” Sacher said. “Issuers are constrained in their ability to manage the single most volatile component of their P&L.”

Rigid restrictions on back-end pricing have translated to changes in the industry’s approach, including more selective underwriting standards, decreased credit availability, and higher interest rates as issuers seek out methods to limit exposure and manage risk. Reduced access to credit, reflected in lower initial credit limits, fewer limit increases, and muted balance growth, has been most severe among non-prime consumers who tend to be more vulnerable and seek to prove their ability to manage credit by earning successive line increases. Instead, consumers may open additional cards or use higher-cost alternative products such as payday loans—negating advances in consumer welfare generated by the CARD Act.

Throughout its commentary, Auriemma urges regulators to reconsider key components of the law, including provisions that establish the current 60-day delinquency trigger for acceptable interest rate increases and ongoing rate review requirements.

Sacher noted that “there are opportunities to maintain strong consumer protections, further align them with sound management principles, and reduce adverse market effects that have taken shape.”

In fact, the CFPB has a track record for responding to industry feedback. In 2012 the Bureau issued a proposed rule to amend the Truth in Lending Act’s (TILA) ability-to-pay requirements, which were having the effect of restricting credit to non-working spouses.

“This was a great example of the regulator taking action to reverse unintended consequences,” Sacher said.

Still, there is room for improvement in the realm of ability to pay.

“The CARD Act’s ability-to-pay requirements rest on the assumption that income and creditworthiness are closely related,” Sacher said. “Having a larger salary might mean you spend more money, but it doesn’t mean you manage credit any better than someone with a smaller budget.”

In addition to the CARD Act’s impact on the cost and availability of credit, Auriemma’s narrative spans a broad range of industry issues including the length and complexity of credit card agreements, the effectiveness of new consumer disclosures, and industry actions to limit unfair, deceptive, and abusive practices. The submission also touches on emerging areas of regulatory interest, such as online disclosures, rewards, add-on products, and ability-to-pay requirements.

The comments respond to a request for information released by the CFPB in March in connection with that agency’s pending review of the consumer credit card market. Information gathered from the public will inform a CFPB report to Congress expected later this year.

The submission marks Auriemma’s latest action to inform policymakers on behalf of its clients in the credit card industry.

 About Auriemma Group

Auriemma is a boutique management consulting firm with specialized focus on the Payments and Lending space.  We deliver actionable solutions and insights that add value to our clients’ business activities across a broad set of industry topics and disciplines. For more information about Auriemma’s Industry Roundtables, please contact Tom LaMagna at 212-323-7000.