Saturday, May 3, 2008

Bernake and Credit Cards: The Good, The Bad, and The Ugly

Bernake's Credit Cards
A loan shark is defined as an individual who lends money at excessively high rates. (1) Unfortunately, a business that was viewed as a tentacle of organized crime has now become common place through various practices of U.S. Banks and their credit card divisions.

Citing another pressure point in the U.S. economy, the Federal bank regulators are developing a swift action plan against abusive credit card companies. Fed Chairman Ben Bernanke trumpeted a reform agenda on credit card policies. The Fed approved a proposal that would generally prohibit credit card companies from increasing the annual percentage rate on a customer's outstanding balances. Bernanke’s proposal would also ban credit card companies from reaching back to prior billing cycles when calculating the amount of interest charges in the current cycle, a practice known as double-cycle billing. (2)

Evidently, the threat of revolving credit card debt poses a significant risk to consumers. While credit card companies do not like additional government scrutiny, bank billing policies have become too aggressive. This does not mean the consumer gets a free ride here. However, if credit cards are going to be the future platform of electronic transactions, then there needs to be a degree of uniformity between banks.

A recent visit to (3) validated some of the basic concerns in the revolving debt model utilized by the credit industry. Credit Cards can fit into three categories: The Good, The Bad, and The Ugly.

The Good... (People with Good Credit)
Depending on the credit rating, a number of credit cards are willing to business on very favorable consumer terms. For instance, a trip to credit mall suggests that there are nearly 100 companies that are willing to extend credit at 0% APR from three all the way to fifteen months! After all, the best credit risks deserve the best cards. Aside from low interest, credit cards are available in other reward categories such as cash, gas, and travel. (4)

The Bad... (People with No Credit)
Students find themselves in a unique situation. While bad credit is viewed as a bank risk, no credit in some circles is viewed as too risky. Interestingly enough, most cards for students (5) all had an initial six months with 0% APR as well. However, the terms of this deal are much different. For instance one offer shows “Two Cycles Average Daily Balance" method when determining finance charges. Wikipedia explains this as "The sum of the daily balances of the previous two cycles is used, but interest is charged on that amount only over the current cycle. This can result in an actual interest charge that applies the advertised rate to an amount that does not represent the actual amount of money borrowed over time, much different that the expected interest charge." (6) In layman's terms, an unfavorable borrowing situation.

The Ugly... (People with Bad Credit)
Consumers with poor credit need plastic as well. And there are several banks which offer them. However, the terms as one would guess are unfavorable including some with no introductory rates. Most of these cards come with a hefty membership fee, an APR that is in the Ozone Layer, and a number of penalties that would make a consumer's toes curl. (7)

Many banks have loosened credit card underwriting standards at a time when consumer debt is spiraling out of control. There are a number of banks who have given credit cards to customers who do not deserve plastic. While this practice is accounted for in most bank business models, it may have a devastating impact on the economy down the road. Now, it appears that government intervention will impact the bottom lines of most, if not all credit card lenders, and major issuers such as DFS, MA, and V. Many individual banks who underwrite credit cards may see a revenue source dry up. This may effect earnings for BAC, JPM, C, COF, and a number smaller banks such as ADVNA, KEY, NCC, RBS, and STI. (8) After all, everyone wanted a piece of this "action". At the end of the day, The Fed calculates that Americans carry $951.7 billion in revolving credit debt. That is a figure which should not be taken lightly! (9)


In conclusion, Bernanke's comments on Friday were a warning shot for
the entire credit card industry. Abusive "loan shark" type lending
practices must cease, and stricter underwriting standards must be applied
forconsumers. Banks must adjust their revolving credit business model.
This willhave a negative impact on earnings short term. Long term, it will
be a good publicrelations move. In the end, there must be a higher degree
of self-policing throughoutthe entire credit card industry. Failure to change
means additional regulations inthe future. (11) In the end, no decent
business would want the title of “Loan Shark.”

Sources Cited
(New York Times)

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