Bank reforms to pinch consumer credit

Call it the law of unintended consequences.

That’s what many finance experts are saying will be the result of Congress’ latest attempt to micromanage the world of consumer credit through the financial-reform measure President Obama signed into law last week.

Many are predicting that well-meaning provisions to force banks to lower their fees for debit card services will boomerang once again and result in less credit available for consumers — the same phenomenon seen when Congress enacted a law a year ago to rein in credit card fees.

Banks reacted to the earlier measure by further constricting credit for consumers — which already has dropped by the biggest amount on record and could fall by an additional $2 trillion in the next year — while abandoning the fees targeted by Congress and raising fees elsewhere to compensate for the lost revenue.

Analysts are predicting that the latest round of restrictions forcing banks to lower their so-called “swipe fees” on debit card transactions will simply prompt banks to raise charges elsewhere. Some foresee the end of free bank checking accounts, as well as the return of annual fees on many credit cards as a result of Congress’ efforts to shave a fraction of the 1 percent to 2 percent swipe fees paid by merchants.

“Regulations may be needed, but they are not free,” said Bill Hardekopf, author of the Credit Card Guidebook. “Banks respond quickly when their income is restricted in one area. Unfortunately, the first victims of these new fees will probably be the people with a basic checking account who need every dollar they make.”

Consumers have grown used to free checking accounts and cards with no annual fees. Such service charges became the exception rather than the rule, as they were during the boom years when credit flowed freely.

But as of this month, one major bank — Wells Fargo — has stopped providing free checking, while Bank of America is testing account fees and other options that it plans to add later this year. Most other banks are expected to join in.

“Banks have already lost billions of dollars in fees and revenue” because of the restrictions on credit card fees and checking account overdraft fees passed last year, Mr. Hardekopf said.

The changes were made at a time when major banks like Citigroup and Bank of America were experiencing record losses because of recession-driven credit card defaults, driving up charge-off rates to as high as 15 percent for some banks.

“The new regulations will increase the losses,” Mr. Hardekopf said. “They have to make changes to increase their revenue” to turn their credit card lines into sound and profitable businesses again.

Since new regulations are designed to make credit and debit cards permanently less profitable, banks also have responded by closing accounts and cutting back credit for customers who are most likely to default and cause losses — accelerating a broad and historic retrenchment in credit that began with the financial crisis in 2007.

The share of consumers using credit cards dropped to 56 percent last year from 87 percent in 2007, while use of debit cards — which directly access a consumer’s bank account for payment — has grown at double-digit rates, according to Javelin Strategy, a banking research group.

Banks have cut credit limits for more than 58 million customers since 2008, slashing limits overall to $3.3 trillion this spring from a peak of $4.7 trillion at the height of the boom, according to JP Morgan Chase.

Chase will no longer offer credit cards to about 15 percent of the people it had been targeting as potential customers.

Partly in response to the legislation, banks may chop off another $2.1 trillion in credit card lines in the next year, wiping out about 45 percent of the spending power U.S. consumers hold on their credit cards today, according to estimates by the Oppenheimer & Co. investment bank.

Such a further retrenchment in credit would have a powerful effect on the economy, contributing to sluggish growth in consumer spending and the economy overall.

Consumers have been trying to pay down their credit card debt, even without coaxing from their banks. Some consumers were prompted to pay off debt by new disclosures banks are required to make in monthly statements showing how long it would take to pay off balances if consumers make only required minimum payments each month.

Polina Vlasenko, a research fellow at the American Institute for Economic Research, said what irks her the most is that responsible borrowers are becoming the new victims under Congress’ “law of unintended consequences.”

“Borrowers with solid credit and a history of paying off their credit card charges on time are treated exactly the same as those with poor credit and a history of late payments,” she said, because banks are no longer allowed to differentiate fees and rates for customers based on good or bad behavior.

People who always paid their bills on time and never went over their credit or checking account limits are now being hit with higher interest rates and fees, the reintroduction of annual card fees, fewer bonus features such as rebates and airline miles, and the refusal of some merchants to accept credit cards without minimum purchases.

Ms. Vlasenko said banks’ practice of differentiating between customers based on credit risks is sound and necessary, and the high rates and fees on credit cards serve a purpose.

“There is a reason why credit cards carry high interest rates. It’s because credit cards provide loans that are convenient for borrowers and risky for lenders,” she said.

“Borrowers can get unsecured loans up to their credit limit on the spot, no questions asked, and can repay these loans at any time. No other financial product allows people to do this.”

Todd J. Zywicki, law professor at George Mason University, said the new swipe-fee restrictions will put a major crimp on consumer spending and the economy, all to satisfy Democratic political constituencies and millions of merchants like Wal-Mart that lobbied to shift a fraction of the 2 percent swipe-fee burden from stores back to consumers and banks.

“Payment cards are a secure, inexpensive, welfare-increasing payment mechanism largely unlike any other in history,” he said.

He predicted that merchants will end up paying a price as consumers revert to cash and other less-efficient paper-payment methods and simply spend less overall.

But consumer advocacy groups charge that banks have forced everyone to pay higher prices at stores to cover their exorbitant charges. Now, they are just up to their old “tricks and traps” by trying to shift fees into new areas.

Activists pledge to keep trying to shut down bank profit centers through the powerful new consumer regulator set up under the finance law at the Federal Reserve.

“Congress can’t write laws fast enough to keep up” with the banks, said Travis Plunkett, legislative director of the Consumer Federation of America. “That’s why we need a Consumer Financial Protection Agency” to keep pursuing banks as they invent new schemes, he said.