Good morning. Today the Consumer Financial Protection Bureau is taking a critical step to address the billions of dollars that Americans pay in penalties to credit card companies. We are publishing an Advance Notice of Proposed Rulemaking to review provisions originally developed by the Federal Reserve Board that allow credit card companies to sidestep Congressional mandates on reasonable penalty fees. Our effort is particularly timely, given that the rule currently allows credit card companies to hike late fees by the rate of inflation.
As always, my remarks reflect the views of the CFPB and do not necessarily represent the views of any other part of the Federal Reserve System.
Credit cards are central to our financial lives. They are the most commonly-held and widely used lending product in America – more than 175 million Americans hold at least one credit card. They are convenient and play a vital role as a payment method to facilitate transactions, enabling us to pay for goods and services in person, online, or with autopay.
While they are a critical payment mechanism, they are also the basis of small dollar loans in America, being an essential tool for people and small businesses. At the CFPB, we know that life creates emergencies and expenses, and many Americans have to live paycheck to paycheck. Access to small-dollar credit lets Americans make better decisions about purchases, buying things that make financial sense in the long run. When used properly, credit cards allow people to carry some short-term debt for the sake of future financial health.
Credit cards should be a safe, secure, and fair source of small-dollar credit in part because Congress has codified important safeguards into federal law. For example, under the Fair Credit Billing Act, liability for unauthorized purchases is limited to $50. And if the card number is being used fraudulently, the cardholder won’t be responsible for any unauthorized charges. These stringent limitations on liability offer consumers peace of mind.
To understand the credit card market in context, it’s important to rewind to the years surrounding the financial crisis and Congressional action to reform the market. During the throes of the financial crisis, there was devastation everywhere. The housing market had crashed. Unemployment had risen to near double digits.
Because regulators failed to adequately detect and address risks in the financial system, Congress and the Federal Reserve Board took extraordinary actions. Americans learned about banks being “too big to fail.” Many financial institutions, including those that operate major credit card businesses, avoided failure through taxpayer-funded bailouts.
The crisis also accelerated public discussion about abuses in the credit card market. Americans were frustrated, and they were complaining loudly and frequently about bait and switch marketing gimmicks, and dealing with agreements full of fine print and legalese they could not decipher. Among the many problems that credit customers faced were excessive junk fees.
In 2009, Congress enacted the Credit Card Accountability Responsibility and Disclosure Act, otherwise known as the CARD Act.
When Congress passed the CARD Act, the law mandated new disclosures and underwriting standards, restricted interest rate increases on balances, and set standards for when credit card companies can penalize their customers with fees. For example, Congress established that bills must be due on the same date each month and that issuers generally cannot charge a late fee unless customers are given at least 21 days to pay their bill.
While many Americans were aware that the Federal Reserve Board is charged with monetary policy and ensuring the safety and soundness of the financial system, the Fed also had important consumer protection responsibilities, including implementing rules regarding consumer financial protection laws enacted by Congress.
With that backdrop and a record high credit card default rate, the Fed came up with amendments to “Regulation Z” addressing one of the most egregious issues with credit cards – back-end penalties. The CARD Act requires that penalty fees imposed by credit card issuers be “reasonable and proportional” to the violation of the account terms. The Fed’s rule said issuers could rely on cost-basis analysis to assess their penalties but they would need to comply with detailed requirements for their calculations.
However, the Fed included provisions in its rules that appeared to allow credit card companies to sidestep this cost-basis analysis. The Fed voted to create “safe harbors” for late fees, over-limit fees, and returned payment fees. These provisions in the Fed’s rule give credit card companies immunity from enforcement actions if they charge fees that aren’t reasonable or proportional. This legal provision to sidestep liability – essentially a go-around – makes it easier on credit card companies to not have to justify their compliance with Congressional mandates governing penalties.
In 2010, when the law first came into effect, those special immunity provisions for late fees – which are the fees the CFPB wants to revisit – allowed a card issuer to impose a $25 late fee for a first incident or a higher fee of $35 for subsequent incidents. This provision allowed card companies to avoid showing that their penalties were in fact reasonable and proportional and to just increase them each year by inflation. For most credit card companies, it appears to be more profitable to charge consumers – not just a lot more interest – but also the maximum amount in penalties authorized under the Fed’s immunity provisions, rather than truly ensuring that their penalties are reasonable and proportional.
Importantly, when the Fed came up with its safe harbor provision, it had no cost-basis analysis of its own on which to base the $25 number. Instead, it looked at things like state laws, research from large issuers, overdraft fees, and laws in the United Kingdom. There was little evidence to support how much it actually costs a financial institution to process a late fee. It also looked at late fees set by small banks and credit unions, but, again, the final rule had no empirical evidence to suggest the fees were correlated with costs.
Today, the legally protected fees for late payments have crept up to $30 for the first late payment, and $41 for subsequent incidents. It has almost become a uniform industry standard among large players to charge the max fee authorized by the special immunity provisions.
In 2010, Congress transferred authorities within the Federal Reserve System from the Federal Reserve Board to the CFPB. It is now the responsibility of the CFPB to ensure that the CARD Act’s rules are faithfully implementing the provision enacted by Congress.
Today, the CFPB is starting an initiative to review the Fed’s credit card rules. We are going to start by looking at late fees, including provisions that give immunity to credit card issuers against enforcement actions for charging late fees and hiking them annually to adjust for inflation. In today’s Advance Notice of Proposed Rulemaking, the CFPB is asking for information on these fees in order to assess whether they really are “reasonable and proportional.”
Several months ago, the CFPB published a report finding that many credit card issuers have made late fee penalties a core part of their profit model. In 2020, credit card companies still charged consumers $12 billion in late fee penalties. This makes up 10 percent of the total cost of credit cards to customers. These fees can hurt millions of families, particularly those with subprime accounts. In 2019, credit card accounts held by cardholders living in the poorest neighborhoods in the U.S. paid twice as much on average in total late fees than those in the richest areas. I am concerned that some credit card companies may actually want consumers to be a little late on their payments, given the billions of dollars in revenue generated on late fees.
Looking at these late fees logically, many consumers question why they are getting dinged several times over. Cardholders who miss making the minimum payment by the due date are already punished by paying interest on their debt. For many consumers, these late fees seem like a second penalty for the same event. In addition, when someone is late, they stand to lose their grace period, meaning they are suddenly paying interest on all new purchases from their transaction date on top of the interest accruing to their last bill.
We are also examining whether it is appropriate for credit card companies to receive immunity from enforcement if they hike the cost of credit card late fees each year by the rate of inflation. Do the costs to process late payments really increase with inflation? Or is it more reasonable to expect that costs are going down with further advancements in technology every year?
Today we are asking card issuers, consumer groups, and the public to provide us with data about late fee safe harbors, the necessity for them, and more. Specifically, we are seeking data and evidence about late fees and late payments, card issuers’ revenue and expenses, and the role late fees play in credit card companies’ profitability. We are not looking for opinions or rhetoric but rather empirical evidence with real data to determine whether the Fed’s special immunity provisions need to be amended.
Today’s notice will inform our rulemaking and help us to ensure we are making the credit card market better for all consumers. Our broader initiative to improve the credit card market will also include better ways to use the CFPB’s existing credit card data collection responsibilities, and taking a closer look at deferred interest promotions, fair competition, and consumers’ fair access to affordable credit.
Congress has already done much of the heavy lifting to put guardrails in the credit card industry. In reviewing the rules put into place by the Fed, we are simply ensuring those guardrails have no weak spots and don’t get weathered with time.
When Congress enacted the CARD Act, some in the credit card industry predicted that the sky would fall. But it didn’t. In fact, the changes made by the law have lowered the overall cost of credit and saved consumers billions in junk fees. Our effort will continue to make sure that Congress’ goal to ensure a fair, transparent, and competitive credit card market holds true.