Frederic S Mishkin: Credit card disclosures
Testimony of Mr Frederic S Mishkin, Member of the Board of Governors of the US Federal Reserve
System, before the Subcommittee on Financial Institutions and Consumer Credit, Committee on
Financial Services, US House of Representatives, Washington DC, 7 June 2007.
The original speech, which contains various links to the documents mentioned, can be found on the US Federal Reserve
System's website.
* * *
Madam Chair Maloney, Ranking Member Gillmor, members of the Subcommittee, I appreciate the
opportunity to discuss the Federal Reserve Board's May 23, 2007, proposal to revise the credit card
disclosures required by current Truth in Lending Act (TILA) regulations. The Board's proposed
revisions to Regulation Z, which implements TILA, also apply to other revolving credit accounts not
secured by a residence. However, I will focus my remarks on credit cards, the subject of this hearing
and by far the most common form of open-end accounts that are not home-secured.
Many more households have obtained credit cards since the Board last reviewed TILA regulations
comprehensively in 1981. In the early 1980s, less than half of American families had at least one
general purpose credit card (43 percent in 1983), and now close to three quarters have at least one
(71 percent in 2004). The increase was sharpest among lower-income families. From 1983 to 2004,
the share of families in the lowest income quintile that hold a credit card jumped from 11 percent to 37
percent. Not only are more consumers holding credit cards, consumers are using their cards more.
Total charges on credit cards increased by about four times from 1991 to 2004 alone.1
Growth in credit card use is explained in part by consumers switching from other forms of credit such
as installment loans. Growth has also been enhanced by changes in consumer preferences related to
the convenience and security of using card forms of payment rather than cash. Another substantial
contributor has been the development of credit scoring and risk-based pricing, which has increased
use of credit cards by consumers who traditionally lacked access because of poor or limited credit
histories.
As credit cards have become more commonplace, they also have become more complicated. Even a
relatively simple credit card account is more complex than the fixed-payment installment loan it may
have replaced. Moreover, most credit cards can no longer be described as relatively simple. Once, a
card may have allowed the user to make purchases or obtain cash advances and applied a single
annual percentage rate, or APR, to each feature. Fees were limited to a fee for cash advances, an
annual fee on the account, and perhaps a fee if the consumer paid late. Today, a card may also offer
balance transfers and treat different classes of purchases and cash advances as different features,
each with its own APR. These APRs adjust much more frequently to respond to changes in the market
or to changes in a borrower's credit risk profile. The typical card no longer has an annual fee, but it has
many other fees tied to a variety of features, or to requirements of the credit agreement, or to a
growing number of optional services.
All of these developments have joined to produce the seeming paradox that credit cards are both
widely used and widely criticized. The Board is keenly aware of concerns over the fairness and
transparency of card marketing and account terms. There is, for example, a concern that issuers
advertise low introductory rates while downplaying that these rates can increase sharply. Observers
worry that the varied reasons that rates can increase, sometimes by a factor of two or three, are not
made clear when the consumer applies for the card, starts to use it, or builds up a substantial balance.
Further, there are concerns that issuers' methods of calculating interest, such as the ways they
choose to allocate customers' payments to different balances, are confusing or not clearly disclosed.
More broadly, the presence in the market of terms seemingly unfavorable to consumers appears to
some to indicate that the market is not fully competitive.
The Board's goals and process
The goals of our proposed revisions to credit card disclosures are to aid consumer decisionmaking
and improve competition. More effective disclosures make information about terms and pricing easier
for consumers to obtain and understand. When that happens, individual consumers are less likely to
fall into "traps for the unwary" and are more able to choose products that offer the best combination of
features and pricing to meet their personal financial needs. Better dissemination of information about
credit card terms and pricing also enhances competition among credit card issuers, which, in turn,
helps generate products that consumers want.
To achieve these goals, the Board's proposal seeks to ensure that consumers receive key information
about the costs of credit card transactions in ways they can understand, in formats they can use, and
at times when it is most helpful. To help us craft a proposal to meet these specific objectives, we
considered the traditional sources: public input we received in over 250 comment letters, available
sources of data and information, and our own long experience implementing TILA. We also considered
what consumers, themselves, had to say. As part of extensive consumer testing, we interviewed
consumers individually about their use and understanding of different disclosures. Consumers told us
what information they find useful when making credit decisions and what information they ignore. We
learned which words and formats for presenting information promote understanding and which do not.
These lessons are reflected in a myriad of preliminary judgments we have made about appropriate
disclosure content, format, and timing.
The judgments required were not always clear-cut. Frankly, it is sometimes difficult to determine which
transaction terms are most important because consumers use credit cards in many different ways. It is
also difficult to determine how much information about those terms is enough; what information should
be highlighted, and what should be disclosed less prominently; what information should be disclosed
early on in the transaction, and what can be reserved for later. The Board also must balance a rule's
specificity, which makes disclosures more consistent and reduces the risk of non-compliance, with its
flexibility, which reduces operational burdens and ensures that disclosures can be adapted to changes
in credit products and practices. In addition, the Board tried to ensure that creditor compliance and
operational burdens are justified by the expected benefits to consumers and competition, and to
reduce existing burdens if they are not warranted.
Developing effective credit card disclosures is particularly challenging because of the complicated and
dynamic nature of the product. First, explaining the effective cost of credit before the consumer uses
the card is difficult because key elements affecting the cost, such as whether the consumer will pay off
balances regularly or carry balances that incur finance charges, are unknown. So TILA requires
disclosures that provide consumers several terms that, together, determine the effective cost of credit:
the periodic rate and nominal APR, other charges such as fixed and minimum fees, the grace period,
and the balance calculation method. Clearly and simply explaining what these terms mean and how
collectively they determine the cost of credit is difficult. Second, effectively disclosing credit card
pricing becomes more difficult as credit card pricing grows more complex with the spread of risk-based
pricing and penalty pricing and the "unbundling" of the price of a credit card into many different types
of rates and fees. Clearly explaining costs contingent on future events that might seem remote when
disclosures are made and promoting awareness of the total cost - not just component costs - pose
additional challenges. Third, credit card pricing and features will continue to change, which means that
we must try to craft disclosure requirements that work today and as products change.
The Board's proposal
Taking all of this into account, the Board has developed a comprehensive proposal to revise
Regulation Z that includes the following specific elements:
•
Advertisements of introductory rates would more clearly disclose the eventual higher rates
and how soon they would be imposed;
• Advertisements of "fixed" rates would be restricted to rates that are truly not subject to
change, either for a clearly disclosed period or for the life of the plan;
•
The "Schumer box" required with credit card solicitations and applications would be updated
to more effectively present information about rates and fees. As can be seen in the attached
model form, the most critical rate and fee information would be presented in the box; rates
and fees would be separated into two sections; and graphic techniques such as minimum
font size, judicious bolding, and vertical alignment of key numbers would make it easier to
read and use;
•
Summary tables similar to the Schumer box would accompany the lengthy, complex credit
agreements that consumers receive both when they first open an account and would also be
provided, later, when account terms are amended. A model of this new disclosure is
attached;
• The penalty rate and penalty fees would be highlighted in the Schumer box and the
accountopening summary table; and a reminder of late payment penalties would appear on every
periodic statement;
•
A consumer would be sent notice forty-five days before a penalty rate was imposed or the
rate was increased for other reasons;
• The cumulative cost of fees would be highlighted every month, as can be seen in the
attached model of a periodic statement. Fees charged in the last cycle would be grouped
together on the statement in a prominent location and totaled for the cycle and year-to-date;
• The periodic statement's "effective APR," another way of disclosing the total cost of credit, is
the subject of two alternative proposals. Under one, the effective APR could be revised to
make it simpler for creditors to compute and potentially easier for consumers to understand.
Under the other, if continued consumer testing, the public comments and the Board's
analysis indicate that the effective APR does not have a meaningful benefit, then it could be
eliminated, as the statute authorizes;
•
Consumers would be warned on the periodic statement about the higher cost of making only
minimum payments, and creditors would be provided incentives to give consumers a more
precise estimate of the time to repay the balance and to place that estimate on the periodic
statement rather than make it available by telephone; and
•
Creditors would receive clearer guidance as to what charges must be disclosed, when, and
how, along with increased flexibility to disclose charges at times and by methods more
convenient to the creditor and consumer alike.
We are committed to providing the public a meaningful opportunity to evaluate and comment on these
and other elements of the proposal, most of which are detailed in Appendix I. The Board has posted to
its web site a lengthy report of its consumer testing, which forms the basis for major elements of the
proposal, and has explained the reasons for the proposal in some detail in over 300 pages of
"supplementary information." The public has four months to submit comment letters, which the Board
expects will contain many useful responses and suggestions.
I want to say more about two elements of the proposal that we expect will elicit vigorous comment.
The first is the proposed new notification requirement when rates are raised. With some exceptions,
the current regulation requires that notice be mailed fifteen days before a rate increase takes effect.
The Board is concerned that this notice can leave consumers too little time to react and possibly to
shop for alternative sources of credit or pay off the existing credit card balance under existing terms.
Further, one of the current exceptions to the fifteen-day notice requirement is for rate increases that
are penalties (for example, for exceeding the credit limit). The Board believes that consumers will not
necessarily anticipate penalty-based rate increases when the penalty was disclosed in credit
agreements they received months, or even years, earlier. Thus, the Board has proposed to lengthen
the notice period for a rate increase to forty-five days and require advance notification of
penaltybased rate increases as well. In practice, consumers would have the benefit of more than a month to
pursue their options, and creditors would forego collecting some interest revenue. The Board wants to
receive comments addressing whether the costs are justified by the benefits.
The two alternative proposals concerning the effective APR on the periodic statement also are
expected to elicit vigorous comment. The effective APR reflects the cost of interest and certain other
finance charges imposed during the statement period. As an example, a cash advance carries an
effective APR that reflects both interest assessed on the balance in the billing period and any fee
charged by the creditor for the cash advance. The effective APR can be quite high, often much higher
than the nominal APR, in part because it amortizes the cost of credit, including fees, over one month.
Although consumer groups argue that the resulting "sticker shock" helps consumers make better credit
shopping and account management decisions, creditors argue that it confuses consumers and
misleads them to think the cost of credit is higher than it is.
Consumer testing conducted for the Board suggests that many consumers have a limited
understanding, if any, of the effective APR, but it also suggests that clearer presentation of the
disclosure can improve understanding. Thus, the proposal seeks to present the effective APR more
clearly to consumers with more straightforward terminology and better formatting that promotes
understanding. In addition, the proposal seeks to improve consumer understanding and reduce
creditor uncertainty by specifying more clearly than the present regulation which fees are to be
included in the effective APR. However, because of inherent limitations of the calculation - such as the
need to assume the repayment period - and continued concern that adequate consumer
understanding may be difficult to achieve, the Board is also seeking comment on an alternative
proposal to eliminate the disclosure. When evaluating these two alternatives, and any others the public
comments might suggest, the Board will consider the comments as well as the results of additional
consumer testing.
Conclusion
Madam Chair, in closing, let me emphasize the Federal Reserve's commitment to ensuring that
consumers get key information about credit card terms in ways they can understand, in formats they
can use, and at times when it is most helpful. We appreciate efforts in the Congress and among
consumer groups and the credit card industry to ensure that disclosure practices are in line with the
needs of consumers. As my testimony this morning indicates, more complex pricing and continuous
change in the marketplace make the task of writing rules for effective disclosure challenging.
Nevertheless, the combination of extensive review, substantial public input, and systematic consumer
testing has enabled us to propose changes that we believe will further the original goals of the Truth in
Lending Act to promote economic stability and competition through the informed use of credit. I look
forward to our continuing efforts in this regard, and I am happy to address any questions you might
have.
Appendix I
Summary of proposed changes to the Federal Reserve Board's Regulation Z
The following summary is organized according to the major disclosures required under Regulation Z.
For more information, see the Federal Register notice the Board approved on May 23, 2007.
Advertisements
Regulation Z requires that advertisements that contain certain information about the cost of a loan
disclose additional information to give the consumer a fuller picture of the cost. The regulation also
requires that terms advertised actually be available.
Advertising discounted
rates. Under a proposal that would implement a Bankruptcy Act requirement,
creditors that advertise a discounted initial annual percentage rate (APR) in connection with an
application or solicitation would have to place the term "introductory" or "intro" near each mention of
that rate. Close to the first mention, creditors would disclose prominently the introductory rate's
duration and the higher rate that would apply afterwards. Creditors would also disclose, in the
"Schumer box," the conditions under which consumers could lose the discount prematurely (e.g., if the
consumer pays late).
Advertising "fixed" rates. Consumer testing indicated that many consumers believe that a rate
advertised as "fixed" will not change and do not understand that "fixed" may only mean that the rate
does not vary based on changes in an index or formula. Under the proposal, an advertisement may
refer to a rate as "fixed" only if the advertisement specifies a period during which the rate cannot
increase for any reason (and the agreement does not give the creditor the right to increase it during
that period), or if the rate will not increase while the plan is open.
Advertising minimum payments. Consumers commonly are offered the option to finance the purchase
of goods or services (such as appliances or furniture) by establishing an open-end credit plan, which
may or may not be accessed by a credit card. These offers often advertise monthly minimum
payments associated with the purchase. Under the proposal, advertisements stating a minimum
monthly payment for an open-end credit plan to finance the purchase of goods or services must state,
as prominently as the minimum payment, the time it would take to pay the balance and the total
amount the consumer would pay if the consumer made only minimum payments.
Credit card applications and solicitations; the "Schumer box"
Under Regulation Z, credit card issuers are required to provide information about key costs and terms
with their applications and solicitations in the form of a table often referred to as the "Schumer box."
The table is intended to help consumers focus on the most important terms when comparing offers
and deciding whether to apply for a credit card account. A model of the proposed new Schumer box is
attached.
Format. Consumer testing showed that the basic format of the Schumer box, the vertical presentation
of information in a tabular format with headings on the left-hand side, is quite effective. Testing also
suggested, however, that reorganizing the information, adding certain new information, and removing
other information would make the box more effective in disclosing today's more complex pricing of
credit cards. The proposed new Schumer box reflects these lessons. For example, consistent with
testing findings, it separates the box into two parts, "interest rates and interest charges" and "fees." In
the first part, it presents each major type of APR, such as a cash advance APR and a penalty APR, in
a separate row instead of grouping them under the single heading "other APRs." The fee section
divides fees into major categories, such as transaction fees and penalty fees; today these fees may
appear below the box, where testing confirms consumers do not readily notice them. Cross-references
between the interest and fees sections were found to help ensure that consumers understand that
both types of costs can apply to the same transaction. The proposed new Schumer box also
incorporates graphic techniques such as a minimum font size of ten points, judicious bolding of text,
and vertical alignment of key numbers. Other changes to the content and format of the Schumer box
are discussed below.
Rates based on creditworthiness. A creditor may disclose at solicitation a range of APRs or several
discrete APRs because it will determine a particular applicant's rate based on an evaluation of
creditworthiness. The proposal would require the creditor to disclose in simple terms, tested with
consumers, that the rate the applicant receives would be based on the applicant's creditworthiness.
Adjustable rates. Currently, if an application or solicitation offers a variable APR, the creditor must
disclose inside the Schumer box the index or formula and the margin used to determine the rate.
Additional details, such as how often the rate may change, must be disclosed outside the box.
Consumer testing indicated that few consumers use details such as the index and margin when
shopping for a card and, moreover, that consumers may be distracted or confused by such details.
Under the proposal, information about variable APRs would be reduced to a single phrase indicating
the APR varies "with the market," along with a reference to the type of index, such as "Prime." Details
about the rate's determination would continue to be disclosed to consumers at account opening.
Fees. Participants in consumer testing often did not notice fees if they were disclosed outside the
Schumer box, as is common today. The proposal requires card issuers to disclose inside the box the
most common penalty fees, namely, fees for paying late, exceeding a credit limit, or making a payment
that is returned. The fee disclosure must also refer the consumer to the penalty rate if, for example,
paying late could also trigger the penalty rate. The most common transaction fees, such as cash
advance fees and balance transfer fees, also would be disclosed inside the box.
Penalty pricing. The proposal would make several improvements to the Schumer box to increase
consumers' understanding of default, or penalty, pricing. Currently, credit card issuers must disclose
inside the box the APR that will apply in the event of the consumer's default. However, they must
disclose the actions that may trigger the penalty APR outside the box, where, according to consumer
testing, this information often goes unnoticed. Under the proposal, therefore, card issuers would be
required to include inside the box the specific triggers of a penalty APR - such as paying late on the
account. Creditors would also disclose the rate that will apply, the balances to which the penalty rate
will apply, and the circumstances under which the penalty rate will expire or, if true, the fact that the
penalty rate could apply indefinitely. The proposal would require card issuers to use the term "penalty
APR" because testing demonstrated that some consumers misinterpret the term "default rate."
Creditors can use the term "default" to refer to one late payment, but consumers sometimes
understand "default" to imply a more serious breach, or to mean something else entirely.
Payment allocation/loss of grace period. The proposal would add a new disclosure to the Schumer box
about the effect on credit costs of creditors' payment allocation methods. It is common for a creditor to
allocate payments first to low-rate balances such as promotional balance transfers. Consumers who
make purchases at a higher rate will not be able to take advantage of any "grace period" on the
higher-rate purchases until they pay off the entire lower-rate balance transfer, which they may not
have intended to do until the promotional rate expired. Consumer testing indicated that consumers are
often confused about this aspect of balance transfer offers; testing also indicated that a disclosure that
is short and simple while accurate and complete is challenging to achieve. The proposal seeks to
balance these objectives in a new disclosure that alerts consumers that they will pay interest on their
purchases until they pay the transferred balance in full.
Subprime accounts. Subprime credit cards, cards offered to consumers with low credit scores or with
credit problems, sometimes have substantial fees associated with opening the account. Typically,
these fees are billed to consumers on the first periodic statement, and can substantially reduce the
amount of credit available to the consumer. For example, the initial fees on an account with a credit
limit of $250 may reduce the available credit to less than $100. Consumers have complained that they
were not aware that so little credit would be available to them. To address this concern, the proposal
would require a card issuer offering a low credit limit and high initial fees or security deposits (25
percent or more of the minimum credit limit) to include in the Schumer box the amount of available
credit the consumer would have after paying the fees or security deposit, assuming the consumer
received the minimum credit limit.
Account-opening disclosures
Regulation Z requires creditors to disclose rates, charges, and related terms such as grace period and
balance calculation method before the first transaction on the account. Consumers' rights and
responsibilities in the case of unauthorized use or billing disputes must also be explained. Currently,
Regulation Z imposes few format requirements on these disclosures and creditors typically integrate
them with the cardholder agreement, which is usually dense and long.
Account-opening summary table. The proposal requires creditors to include a table summarizing the
most important terms in an easy-to-follow format, substantially similar to the Schumer box the
consumer typically would have seen with the application. An example of this new table is attached.
Fees. Under the current rules, a creditor must disclose any fee that is a "finance charge" or "other
charge" in the written account-opening disclosures and generally has no obligation to disclose it again,
unless the charge is increased. New fees added to the plan after account opening must be disclosed
before they take effect and later if they increase. (Of course, after a fee is charged, it must appear on
the periodic statement; disclosure at that stage is discussed later.) Creditors have sometimes had
difficulty determining whether a particular fee is properly classified as a "finance charge" or "other
charge," or as neither of these. Although the regulation and commentary give specific guidance,
sometimes new services develop before the guidance can be updated. When that happens, creditors
can find it difficult to determine if the fee for the service must be disclosed in writing at account
opening (or before the fee takes effect, if a service is added later). This uncertainty can pose legal
risks for creditors that act in good faith to comply with the law, and it can lead to inconsistent
disclosure to consumers.
Moreover, it is not clear that consumers benefit from requiring creditors to disclose every potential fee
in writing and at account opening. It may be months, and possibly years, until the consumer requests
the service for which the fee is imposed. Furthermore, the consumer may request the service by
telephone for speed and convenience, and not expect to have to wait for a written disclosure before
the transaction can be completed.
The proposal seeks to address these potential limitations of the present rule while taking into account
the Truth in Lending Act's (TILA) requirement to disclose plan-related charges before they are
imposed. Accordingly, under the proposal, the rules would be revised to2 specify precisely the charges
that creditors must disclose in writing at account opening (interest, minimum charges, transaction fees,
annual fees, and penalty fees such as for paying late), which would be listed in the summary table
referred to above; and (2) permit creditors to disclose other charges, typically fees for optional services
that may be used infrequently, orally or in writing before the consumer agrees to or becomes obligated
to pay the charge. To prevent abuse of this flexibility, the proposal requires that an oral disclosure be
clear and conspicuous, and that it be given when the consumer would likely notice it.
Periodic statements
Once an account has been opened, creditors are required to provide periodic statements reflecting the
account activity for each billing cycle, typically monthly. The statement must identify each transaction
on the account, such as a purchase or cash advance. It must also identify each "finance charge"
(using that term) and other charges imposed as part of the plan during the cycle. And it must identify
the periodic rate(s) and corresponding annual percentage rate(s), also known as the nominal APR,
that applied during the last cycle. If finance charges were imposed in the form of fees (e.g., a cash
advance fee), as well as (or instead of) monthly interest, then the statement must disclose an effective
total
APR reflecting the finance charge, with limited exceptions. Under amendments to TILA made by
the Bankruptcy Act that are implemented in this proposal, creditors must also disclose information
about the cost of paying late or making only the minimum payment due. A model of the periodic
statement that reflects the revisions discussed below is attached.
Transactions. As the regulation currently permits, transactions are often presented in chronological
order and not by transaction type. Participants in consumer testing found it easier to read and use
statements where similar types of transactions are grouped together. Accordingly, the proposal
requires creditors to group similar transactions together by type, such as purchases, cash advances,
and balance transfers.
Fee and interest charges. The proposal contains a number of revisions to the periodic statement to
improve consumers' awareness and understanding of charges they have incurred in the form of fees
or interest. Consumer testing indicated that consumers have difficulty understanding the term "finance
charge." They are more likely to conceive of their charges as "interest," the charge that results from
applying a rate to a balance, and "fees," such as a cash advance fee or a late payment fee. Consumer
testing also indicated that many consumers more easily compute the number and amount of fees
when the fees are itemized and grouped together. Participants noticed fees and interest charges more
readily when they were located near the transactions. Also, many participants more quickly and
accurately determined the total charges for the billing cycle when a total fee amount for the cycle was
disclosed, as well as the total interest.
These findings led the Board to propose four changes to fee disclosures on the periodic statement.
First, creditors would no longer have to label charges as "finance charges;" they would instead classify
charges as "fees" or "interest." Second, creditors would be required to group all charges together in a
discrete place on the statement under the headings "fees" and "interest charges." Third, these charges
would appear near the transaction items. Fourth, creditors would disclose the total fees and total
interest imposed for the cycle, and the totals for the year to-date.
The effective APR. The effective APR disclosed on periodic statements reflects the cost of interest and
certain other finance charges imposed during the statement period. For example, for a cash advance,
the effective APR reflects both interest assessed on the balance in the statement period and any fee
assessed for the advance. The effective APR can be quite high, often much higher than the nominal
APR, in part because it amortizes the cost of credit, including fees, over one month. Although
consumer groups argue that the resulting "sticker shock" helps consumers make better credit
shopping and account management decisions, creditors argue that it confuses consumers and
misleads them to think the cost of credit is higher than it is.
Consumer testing suggests that many consumers have a limited understanding, if any, of the effective
APR, but it also suggests that clearer presentation of the disclosure can improve understanding. Thus,
the proposal seeks to present the effective APR more clearly to consumers, giving it an intuitive label
of "fee inclusive APR" and placing it next to other, related information such as the interest and fees it
includes. In addition, the proposal seeks to improve consumer understanding and reduce creditor
uncertainty by specifying more clearly than the present regulation which fees are to be included in the
effective APR. However, because of inherent limitations of the disclosure (such as the need to assume
the repayment period) and