Board of Governors of the Federal Reserve System

May 2, 2008

Today, the Federal Reserve is taking the next step in its ongoing effort to enhance protections for consumers who use credit cards by proposing rules under the Federal Trade Commission Act (FTC Act) to address unfair or deceptive practices. Our first step was the Board's proposal to substantially revise and improve credit card disclosures under the Truth in Lending Act (TILA). We are still carefully considering the public comment letters received on that proposal, many of which contain suggestions for how we might further improve the disclosures. We are also continuing to use consumer testing as we work toward issuing final rules by year-end.

We believe that our previous proposal will result in credit card disclosures that are significantly more effective for today’s complex products. Testing disclosure forms and formats with real, live credit card users is crucial to ensuring that the disclosures are understandable and useful to consumers. Effective disclosures can help to empower consumers and enhance the competition as consumers find it easier to comparison shop.

The Board received more than 2,000 comment letters from individual consumers--not simply form letters--who shared their personal experiences and concerns about their accounts. Consumers' letters focused principally on card issuer practices that some have characterized as "traps for the unwary." These practices can substantially increase consumers' costs and make it more difficult for them to pay down their debt. In addition, just last month, I hosted at the Federal Reserve a forum on credit cards where we had a lively roundtable discussion of these issues among industry representatives, consumer advocates, and bank supervisors. Hearing the participants' viewpoints was useful during our development of the proposed rules.         

The Federal Reserve's experience with consumer testing suggests that disclosure alone is not likely to be sufficient to address these issues. Accordingly, the rules we are proposing today would go beyond disclosure and require financial institutions to make changes to their business models and to alter some practices. If the rules are adopted, consumers may see some costs decline as new business models emerge, while other costs might increase. The intent is to increase transparency and fairness in how credit card and deposit accounts operate, thereby enhancing competition and empowering consumers to better manage their accounts and avoid unnecessary costs. 

One of the practices cited most often by consumers is card issuers' practice of increasing interest rates retroactively to cover past extensions of credit, sometimes for reasons that are not apparent to consumers. Consumers also raised concerns about card issuers' allocation of payments in ways that maximize interest charges, and about not receiving periodic statements early enough to pay by the due date and avoid penalties. Consumers' comment letters and our own consumer testing show that, given the complexity of credit card products and card holder agreements, it has become increasingly difficult for reasonably diligent consumers to rely on disclosures to avoid these pitfalls and the unnecessary costs that can result. The concerns expressed by individual consumers have been echoed by consumer advocates and some members of the Board's Consumer Advisory Council.  

Accordingly, it is appropriate that we now consider a new approach to prevent financial harm to consumers from specific practices. The FTC Act provides us with the necessary tools by authorizing the Board to issue rules for banks to prohibit acts or practices that the Board finds to be unfair or deceptive. That Act provides the same authority to the Office of Thrift Supervision (OTS) for thrifts and the National Credit union Administration (NCUA) for credit unions. Working jointly with the OTS and NCUA, we have identified a number of unfair or deceptive credit card practices and have developed uniform rules to remedy these practices.  Among other things, the proposed rules would address the following:

• Creditors would be required to provide consumers a reasonable amount of time to make payments before they are considered late;  

• As a general rule, for accounts having multiple interest rates for different balances, creditors would be prohibited from maximizing interest charges by applying payments exceeding the minimum to the lowest rate balance first.

• Creditors would no longer be permitted to increase the interest rate on existing account balances at any time for any reason. Instead, card issuers could only apply a higher rate to the existing balance under limited circumstances, such as when a consumer has been delinquent for 30 days. Of course, creditors could still increase the rate on new transactions, and could offer variable rate cards where the rate on existing balances adjusts based on changes to an index.

• Creditors could no longer accrue finance charges using the two-cycle balance computation method; and 

• The rules also address a practice associated with some subprime credit cards, by prohibiting the issuance of cards where most of the credit limit is used up before the consumer receives the card, due to security deposits and high fees imposed at account opening.

Unfair practices can impose significant costs on credit card users. The new proposed rules would provide the benefit of substantial protection against practices that can harm consumers. Once we publish the FTC Act proposal, we will have a 75-day comment period in which we are looking forward to comments on the costs and benefits.

In addition to rules for credit cards, today's proposal also addresses unfair practices in connection with banks' payment of overdrafts. Institutions commonly process payments using automated programs that make overdraft loans to consumers on a routine basis, often without the consumers' knowledge. Many consumers are surprised to receive monthly statements showing costly fees for withdrawals made at automated teller machines and for debit card purchases that were approved at the point of sale.  

The proposal would require depository institutions to provide consumers a clear opportunity to opt out of the institution's automatic payment of overdrafts, consistent with guidance issued by the federal banking agencies in 2005. The rule is intended to give consumers more control, so that they can better manage their accounts and decide whether they want banks to pay such transactions. We intend to conduct consumer testing in the near future to ensure that the notices consumers receive are clear and effective.

Lastly, in addition to the proposed FTC Act rules, complementary amendments are being proposed to the Truth in Lending Act rules in Regulation Z and the Truth in Savings Act rules in Regulation DD. Several revisions to the Board’s previous proposal are also being issued based on further consumer testing that we conducted on the new open-end credit disclosures.      

Before turning the floor over to Sandy Braunstein, Director of the Board's Division of Consumer and Community Affairs, I want to thank her and so many members of her staff for their extraordinary efforts on these proposals:  including Leonard Chanin, Jim Michaels, Ky Tran-Trong, Krista Ayoub, and Ben Olson.