The Federal Reserve Board (FRB) has recently proposed amendments to its Truth in Lending regulation, Regulation Z, designed to implement the Credit Card Accountability Responsibility and Disclosure Act of 2009 (Credit Card Act). The proposal primarily deals with the issues of penalty fees and annual percentage rate (APR) increases.
The proposed rule would implement the mandate of the Credit Card Act that the FRB establish reasonableness standards for credit card penalty fees. It would generally apply to fees that are imposed due to acts or omissions by the cardholder that violate the terms of the account, other than charges related to periodic interest rates. Such fees include, for example, late payment fees, fees for payment checks returned for insufficient funds and over-the-limit fees.
The FRB’s proposed approach is to establish alternative bases upon which a credit card issuer could charge penalty fees. An issuer could charge a penalty that it determines represents a reasonable proportion of all the costs incurred by the issuer as a result of that particular type of violation. The proposal is for a fee based on the issuer’s general overall cost experience, not on a specific violation on a specific account. An example given is an issuer charging a late fee based on a borrower’s proportionate share of aggregate collection costs.
Another proposed option is for the issuer to charge a fee based on the need to deter the violation. Such a fee would need to be based on “empirically derived demonstrably and statistically sound” modeling “that reasonably estimates the effect of the amount of the fee on the frequency of violations.” The modeling must demonstrate that a lower fee would increase the frequency of the particular type of violation.
The proposed rule would generally prohibit, as unreasonable and disproportionate, penalties that exceed the dollar amount of the violation. For example, an over-the-limit fee could not generally be more than $10 if the card holder exceeded the limit by less than $10. Other fees would be banned where there is no dollar amount associated with the violation. Those include fees based on inactivity or the closure of an account or on a transaction that the issuer declines. Multiple penalty fees based on a single transaction, for example, a late payment fee and a returned check fee based on the same payment, would also be prohibited.
The FRB noted an intention to develop a safe harbor that provides a single penalty fee amount sufficient to cover an issuer’s costs and deter violations. The FRB’s concept is establishing the safe harbor at the greater of a specific dollar amount or 5% of the dollar amount associated with the violation (up to a specified cap). The proposed rule does not contain a specific dollar amount because the FRB indicated that it did not have sufficient information to set the amount. It requested that commenters provide, for the FRB’s consideration, data on costs incurred due to violations and the deterrent effect of varying fee amounts.
The proposed rule would also implement the requirement of the Credit Card Act that issuers that increase an APR based on the credit risk of the customer, market conditions, the issuer’s cost of funds or other factors, periodically reevaluate the account and consider whether circumstances would allow reduction of the APR. Relevant factors for review include the factors upon which the rate increase was originally based or the general criteria that the issuer reviews when establishing APRs for accounts.
The proposed rule would require issuers to conduct a review no less frequently than once every six months (unless the rate is otherwise reduced) and reduce the APR if appropriate. The Credit Card Act requires that such a review be conducted on accounts on which an issuer has increased on APR since January 1, 2009. The review requirement would not apply where an increased APR results from the expiration of a properly-disclosed teaser rate or the fluctuation of an index for a variable-rate account. The proposed rule also contains proposed disclosure requirements designed to carry out the substantive restrictions.
The proposed rule represents the third and final stage of the implementation of the Credit Card Act. Comments are being accepted by the FRB for thirty days after the publication of the proposed rule in the Federal Register. The Credit Card Act requires an effective date of August 22, 2010, for the penalty fee and APR review provisions.