The law of unintended consequences usually applies to either legislation or bureaucratic rule making, and judging from the comments of local bankers and financial trade representatives, a new rule pertaining to credit card fees will bring consumers more harm than good.
In a move designed to protect consumers, the federal Consumer Financial Protection Bureau (CFPB) finalized a rule on March 5 that caps credit-card late fees — what the bureau calls junk fees — at $8. The rule effectively cuts the average fee from $32 to $8 for larger credit card issuers, defined as any issuer that, together with its affiliates, has one million or more open consumer credit card accounts. The rule also eliminates an annual inflation adjustment established 15 years ago during the federal government’s response to the Great Recession.
In effect, the rule slashes the safe harbor amount that the Federal Reserve set for those fees — and every previous CFPB administration has maintained — by 75%. Previously, larger credit card issuers could take advantage of the safe harbor provision to charge up to $30 for the first late payment and up to $41 for any subsequent late payment within the next six billing cycles (not including the annual inflation adjustment).
The CFPB says the action will rein in so-called junk fees on credit cards, increase competition, and put billions of dollars back in the pockets of American families. The bureau estimates the change will limit late fees for more than 95% of all outstanding balances in the credit card market and will save families $10 billion each year, an average savings of $220 per year for the more than 45 million people who are charged late fees. The impact on consumers is one of the reasons the rule earned plaudits from organizations such as the National Consumer Law Center.
While the cap on late credit card fees is 75% less than the typical past-due charge, the bureau may not be done capping fees. In January, it proposed to cap bank overdraft fees as low as $3. (At press time, the proposed rule had not been finalized).
On the flip side, the rule was opposed by trade groups in the financial-services industry, which filed a lawsuit to challenge the rule. Given the potential hit to bank revenue, some of which is raised to cover expenses related to late payments, banking interests lobbied against the rule. They also point to the potential for future damage to consumers. Among those potentially negative consequences are reduced access to credit and cost shifting that penalizes consumers with good repayment records.
To assess the potential downsides for consumers, we spoke to Rose Oswald Poels, president and CEO of the Wisconsin Bankers Association (WBA); Ken Thompson, president and CEO, and Gary Kuter, senior vice president, chief risk and compliance officer, Capitol Bank; and Jim Tubbs, CEO of Lake Ridge Bank in Madison. Thompson is a former chair of the WBA and sits on the Federal Home Loan Bank Board of Chicago, and Kuter is the former chair of the WBA’s Government Relations Committee.
They all object to the term junk fees, which suggests they are hidden fees. Given how heavily regulated the financial industry is, they note that banks go to great lengths to avoid have anything hidden. The Truth in Lending Act requires banks to have all of their fees completely transparent and well known to the consumer before entering into any type of product or service, and the Federal Deposit Insurance Corp. [FDIC] conduct audits to ensure compliance.
Oswald Poels says the term junk fee is a disservice to the industry and to the public. “To me, it implies that it’s a fee intending to gouge consumers, and it also implies to me that it’s a surprise fee,” she states. “None of that is true.”
Here is how Oswald Poels and the bankers we interviewed believe the cap on late fees will harm consumers:
Less credit access
According to the CFPB, industry data reveals that large banks that dominate the market are charging interest rates 8–10 percentage points higher than small banks and credit unions, regardless of credit risk, which represents a massive difference. Just prior to issuing the late fee rule, the bureau issued guidance to address kickback payments that are turning purportedly unbiased comparison-shopping tools into digital advertisements — undermining the competitive process.
The bureau also notes that when consumers don’t make required payments, they can face a long list of consequences. For example, they pay extra interest, their credit report takes a hit, their credit line can get cut, and they can face a late fee. “However, late fees and other penalties aren’t supposed to be a core profit driver, since this would mean that credit card companies might benefit more when consumers miss payments,” the bureau states.
In contrast, one of the points made in the lawsuit challenging the rule is that the rulemaking process violated the Dodd-Frank Act by not considering the cost to consumers of reduced access to credit. Cutting late fees may sound good for consumers, but American Bankers Association (ABA) research shows that late fees, once set at a certain amount, actually encourages consumers to pay on time. That may come from one of the main trade organizations for the banking industry, but it notes that late fees are hardly the sole province of the financial services industry because if you are late to pay your federal taxes, you are assessed a fee.
“Both private industry and the federal government use late fees as an appropriate tool to incentivize payment,” Tubbs explains. “If you put this late fee really low or lower than where it is now, people might not be incentivized [to pay on time].”
The concern there is that, especially when it involves an extension of credit such as credit cards, a late fee creates a delinquency on a consumer’s credit bureau, which will lower their credit score and cause them to have higher interest rates because they’re now deemed a greater risk. So in Tubbs’ view, the CFPB actually is harming consumers’ ability to get a mortgage loan or to refinance their mortgage to get a more favorable interest rate. According to Tubbs, the rule also could negatively affect their ability to get additional credit cards, and it potentially affects how prospective employers view them if they look at credit scores.
Thompson notes that price caps in most industries generally have negative impacts that weren’t expected, and they harm a variety of people that are purportedly helped. “If you make late payments easier for consumers, you can easily come to the conclusion that they will likely be past due more often,” he states, “and more past due loans are reported to credit bureaus. The poor credit score does far more damage than any fee that you could charge because now they’re using credit reports not only for gaining credit, but for insurance products and everything else.
“And so, it’s very indicative of performance,” Thompson adds. “It’s really important that we have these guardrails.”
Reduced rewards
According to the CFPB, the credit card industry hauls in more than $14 billion in late fee revenue each year, and its research shows that this revenue is more than five times the companies’ associated costs. “They charge these fees to consumers even when their payment is only a little bit late or when it’s out of their control,” the bureau states. “This is on top of extra interest charges, negative credit reporting, and a slew of other consequences.”
Bankers view it differently, contending the rule caps credit card late fees below banks’ actual costs. Local bankers note that one of the casualties of the cap on credit card late fees could be the rewards programs or cash-back or points benefits that credit card issuers offer to consumers who pay their bills in full and on time.
According to Kuter, hotel and travel rewards, for example, could be one of the casualties. “The credit card companies are the ones using the income, some of their interchange fees, some of their income from these types of fees, to help support those [rewards], and those could be reduced if not eliminated” by the limits on late fees, Kuter states.
Contrary to popular opinion, Thompson notes that banks, however much income they derive from late fees, would rather have a current credit card than a past due card because of the expense involved for both banks and credit card companies, which have large collection departments that they need to support. “When we get a past due one, now we have to get on the phone, now we have to send notices. Now we have to potentially collect,” he explains. “So now, you try to collect on that. It’s not fun. The way they depict these things is that the banks would like people to be late so they can charge the fee, and that’s just not the case.”
If the reduced late fee causes more late payments, the credit card companies may hire more collection staff and pass on the costs, and banks will have to look at the higher cost of issuing credit. “The interest rates may have to be moved up, and that affects people who aren’t even late at all,” Thompson notes. “Then it’s [affecting] the people that are paying on time, so now that’s another unintended consequence because they’re going to have to cover their costs somehow.”
Thompson also cited a key incentive to paying on time, one that tends to get lost in the conversation over late payments. “Typically, if you have a charge within a given month, you have a 25-day grace period that if you pay it in full, there’s 0% interest, zero carrying cost,” he notes. “This is generally how it works … So, there is ample time to be able to make a payment, and what a great tool to be able to utilize, to have access to dollars and not have to pay any interest on it for a good chunk of time. That’s a real benefit to a lot of people that you don’t hear anything about.”
Fewer choices
The new rule requires large card companies to either charge a maximum late fee of $8 or justify a higher amount by demonstrating that they need to charge more to cover their actual collection costs.
Since federal bank examiners look very closely at a bank’s financial health, banks naturally try to cover the expenses associated with issuing credit cards, the marketing of the credit cards, and the management of the payments, and part of that expense covering is done through late fee collection. Some banks could just decide that they’re going to get out of the credit card business. Every bank will have to make its own decision about that, but one possible scenario is that banks only extend credit cards to people with high credit scores because they won’t be late with their payments.
Another expense factor for the credit-card industry, one that has taken off over the past 15–20 years, is the amount of fraud. “Fraud protection services are expensive, as you can imagine,” states Thompson. “It’s not all fun and games. A lot of banks have exited business because the fraud losses exceed credit losses. There is a lot of cost to doing this particular business.”
According to Tubbs, rural credit is another potential victim. “If you’re in a small rural community anywhere in Wisconsin, your source of capital is a small community bank that’s sitting in your small town,” he notes. “If that small community bank now says, ‘You know what, it’s because of regulations from Washington, D.C. and we’re going to get out of the credit card business.’ Now where does that community go to get their credit? Are they going to sign up for Capital One and have no idea who they’re dealing with?”
Downstream damage
While the rule pertains to larger credit card issuers and the banks they serve, smaller community banks could be sucked into the vortex and follow suit with lower late fees. The $8 cap could actually become a competitive advantage for larger banks. “With this particular rule, another unintended consequence to a community bank is ‘OK, well, now I can go to that large bank. I’m only going to get charged $8 for the fee there,’” Kuter says. “The community bank might be charging $25 and now you’re squeezing them out because we know that there’s a cost, and the cost is much higher than $8. The community bank would normally charge more than $8, but it’s going to force the community banks unintentionally to go to $8 because of competition. It’s so large of a difference. It’s not like they just reduced it 10%; it went down 75%.”
According to Oswald Poels, the CFPB does this in many contexts with the rules it issues. “They say, ‘Well, it only applies to card issuers that have a million or more credit card accounts,’ and certainly community banks don’t have that,” she notes. “The reality is that a lot of community banks are leveraging a larger card issuer’s platform to issue their card, and so it’s going to be a lot harder for the credit card companies to say, ‘Well, OK, this card is being issued by JP Morgan Chase, so the late fee can only be $8,’ but we have to somehow configure the system to know that it’s a community bank here that’s issuing this card.”
Healthy banks
The new focus on bank and credit-card fees comes at a time when Wisconsin banks are robustly healthy. The bank failures of 2023 turned out to be isolated, not systemic, and in the year-end appraisal of the FDIC, state-chartered banks are in good financial shape, even with higher interest rates eroding their net interest margins from 3.27% in 2022 to 3.20% last year. The economy remains strong, deposits have stabilized, and while the percentage of past-due loans increased as inflation rose, they still are historically low.
The most significant headwind, however, is an inverted yield curve, also known as a negative yield curve. For more than two years, the inversion of the 2–10 yield curve — meaning the yield on the two-year treasury has consistently exceeded the yield on the 10-year treasury — has had many economists worried. When long-term interest rates are less than short-term interest rates, causing yields to decrease the farther away from the maturity date, this is closely watched by economists because every inversion dating back to 1970 has preceded a recession. When the Federal Reserve rapidly raised interest rates in 2022 to fight inflation, it created the current inverted yield curve, but so far in an economy still benefitting from massive federal stimulus and marked by a labor shortage that prevents mass layoffs, that yield curve-recession relationship has yet to cause an economic downturn.
In terms of recession avoidance, the U.S. economy is certainly not out of the woods, especially with a concerning decline in national business investment. From a banking perspective, lower interest rates, which the Fed has signaled but not confirmed for the second half of 2024, could not come soon enough.
“Those inverted yield curves are a challenged equation for the banking industry’s profitability,” Tubbs explains. “They just cause our net interest margin to be squeezed, so we are really looking forward to the day when the Federal Reserve starts easing its policy on higher interest rates. When interest rates start to come down, bankers feel like there’ll be a little bit of relief on the net interest margin.”
The CFPB rules: Is bureaucratic oversight now out of mind?
Among the complaints that bankers have of the Consumer Financial Protection Bureau (CFPB), led by Director Rohit Chopra, is that it’s not accountable to any other part of the government. So, when the final rule was handed down on credit card late fees, and no adjustments were made following industry testimony (a rarity, bankers say), the financial industry was not pleased.
“There’s no congressional oversight, and so it’s just a regulator — this cop that’s both the judge and the jury,” states Jim Tubbs, CEO of Lake Ridge Bank. “That in itself is very concerning if the bureau can go ahead and have this element of power and get the president’s attention where now he’s signing executive orders in order to put things in play. That is of great concern.”
Other bankers note the inconsistency between Chopra and past CFPB administrators. “They mischaracterize it as a junk fee, like the bank doesn’t disclose these fees, and we’re required to disclose these fees before they even transact business,” states Gary Kuter of Capitol Bank. “So, that $32 fee was out there since 2010 and every previous CFPB director said that it was a customary and reasonable fee, and now all the sudden it’s not reasonable and that’s being cut by 75%. That’s where the banks are pushing back.”
The American Bankers Association could not agree more. Shortly after the rule capping late credit card fees was finalized, the ABA joined the U.S. Chamber of Commerce and several other business organizations in filing a lawsuit against the CFPB that challenges the new rule. The plaintiffs are also seeking a preliminary injunction barring the bureau from implementing the rule.
In the filing, ABA and its co-plaintiffs argue the CFPB exceeded its statutory authority and offered deficient analysis and reasoning — all in order to achieve a pre-ordained outcome that will ultimately harm those consumers. The ABA and its co-plaintiffs’ arguments for challenging the rule and seeking a preliminary injunction include charges that it violates the Credit Card Accountability Responsibility and Disclosure Act (CARD Act) of 2009 by preventing issuers from collecting reasonable and proportional late fees when cardholders don’t pay their bills on time; that it violating the Administrative Procedure Act by promulgating a final rule that is arbitrary and capricious, relying on incomplete and nonpublic data to estimate card issuers’ costs; and that it violates the Dodd-Frank Act by failing to sufficiently consider the costs to consumers, including the reduced access to credit that they charge will result from the final rule.
Rob Nichols, president and CEO of the ABA, echoed local bankers who contend the rule will not only reduce competition and increase the cost of credit, but will also result in more late payments, higher debt, lower credit scores, and reduced credit access for those who need it most. “The bureau’s misguided decision to cap credit card late fees at a level far below banks’ actual costs will force card issuers to reduce credit lines, tighten standards for new accounts, and raise APRs for all consumers – even those who pay on time,” he states. “It comes as the CFPB continues to use misleading blog posts and irresponsible press statements to paint an inaccurate and distorted picture of today’s highly competitive credit card market, which offers consumers a wide variety of card programs and features they value – provided by banks of all sizes across the country.”
Persistent debt
In announcing the rule, the CFPB counters that the rule comes after an extensive process, consideration of thousands of comments, and a great deal of research into the credit card market. In the month prior to the rule, the bureau released a report that found credit card interest rate margins, or the difference between the prime rate and the APR (annual percentage rate) charged to the consumer, are at all-time highs. It claimed that what it calls excess margins cost consumers an extra $25 billion in annual interest charges in 2023 alone. “We have learned a lot, and we have real concerns about how the competitive process is working in this market,” the bureau states. “And these higher rates don’t just cost more, they make it harder for families to pay off their growing balances. Our research has found that many consumers are trapped in ‘persistent debt,’ meaning that they pay more in interest and fees than principal.”
More than a decade ago, the bureau notes that Congress voted to pass the Credit Card Accountability Responsibility and Disclosure (CARD) Act to clean up abuses in the credit card industry, and one of the central components of the CARD Act was a prohibition on excessive penalties such as late fees. In the law, Congress allowed credit card companies to charge “reasonable and proportional” fees to incentivize on-time payment and cover the costs associated with late payments. At the time, the Federal Reserve Board of Governors was responsible for developing regulations to implement the law.
In 2010, the CFPB believes the Fed board started to undermine the CARD Act’s intent, voting to include an immunity provision in those regulations. In the bureau’s view, the immunity provision allowed credit card companies to evade the “reasonable and proportional” penalty fee requirement, as long as they stayed below a threshold.
In its review, the CFPB contends that this has turned into a massive loophole that has allowed companies to charge unjustifiably high fees ever since. Its research shows that borrowers with low credit scores are, on average, charged $138 per year per card.
“Almost all of the credit card giants have hiked their fees every year in lockstep, using inflation as an excuse,” the CFPB states. “Because banks are allowed to charge fees far in excess of costs [a charge that banks deny], the current rule means large banks profit when borrowers inadvertently miss a payment or struggle to pay on time, and many do, repeatedly. The status quo makes late fees an irresistible revenue stream, disincentivizing card companies from making it easy and simple to pay your bill on time.”
In the bureau’s view, the new rule closes a loophole abused by credit card giants, one that will help consumers keep more of their money and hold credit card companies to the original intent of the CARD Act.
