For years, federal deposit insurance has been a prerequisite for issuing credit cards. Whether formal or informal, it's a silly and outdated requirement — and Discover has finally gone around it.
The smallest of the four major networks is permitting the little-known Continental Finance to offer subprime credit cards indirectly. The new Continental Discover card is one of very few unsecured cards on the market for which subprime consumers qualify. Its rarity is a reminder that open and uniformly regulated competition is lacking in the credit card business.
Visa and MasterCard have permitted credit card issuance on their networks only by institutions with federal deposit insurance from the FDIC or NCUA. Amex and Discover exclusively issued cards on their respective networks until 2004, when the outcome of an antitrust case freed them to court Visa and MasterCard member banks. Many months ago I suggested to Discover that they issue also for nonbank lenders but the company refused.
In the past, federally insured institutions issued MasterCard and Visa cards for a few nonbank lenders under arrangements referred to as "bin rental." The lender bought all the new balances the day they were created, conducted all operations, took all risk and made most of the profit. I arranged the first of these relationships, with a bank in Louisiana for the nonbank Associates Corp. It worked very well. Eventually Citigroup acquired Associates.
In a few instances when a card program allegedly violated laws or regulations, regulators severely punished the issuing banks. One such case resulted when First Bank of Delaware issued MasterCard cards for Continental and for CompuCredit in the mid-aughts. (Continental says it has sold a cumulative 1.3 million cards through various partners.)
In 2008 the FDIC ordered the bank to cease and desist, pay restitution and a fine and accept restrictions on its operations, primarily because of alleged disclosure violations. According to the FDIC's Notice of Charges relating to Continental's program, "the Bank represented…that consumers would receive a [Continental] Card with $300 of available credit. In fact, consumers…received only $53 or $75 of available credit due to the significant fees billed immediately to their accounts."
More recently, federal banking regulators have not permitted new bin rental programs by insured institutions for credit cards, although they have allowed nonbank "program managers" such as GreenDot and NetSpend to market prepaid card programs via bank issuers of debit cards.
That's not an issue for Continental's card, whose issuer, Services Credit Union, is chartered by Illinois and neither federally insured nor federally regulated. However, Services' status as a state-chartered, uninsured credit union also presents a disadvantage for its partner: Continental's new Discover card, available in close to 40 states, is subject to state usury and other regulations to which bank-issued cards are not.
For bin rental deals to have any substance or credibility, the bank needs resources that are substantial relative to the card program's potential liabilities. It also needs the competence and ability to assure compliance.
According to CreditUnionAccess.com, Services has assets of $213,000 and no full- or part-time employees. Because it lacks federal insurance, the credit union would be very unlikely to be able to issue cards through Master Card, Visa or Amex.
The credit union seems to be an affiliate of the Illinois Credit Union League, which has the same president, Dan Plauda. I couldn't find any mention of Services on the Continental web site taking card applications, although disclosure of the lender's name is an industry standard, even with bin rental.
Discover revealed Services as the issuer, but did not reply to my e-mail asking about its conditions for permitting issuance by lenders without deposit insurance. Services did not reply to my e-mail seeking information. Continental made executives available by telephone, but they were reluctant to say much of anything, for competitive reasons.
The new Continental Discover card offers a $300 line of credit with an APR up to 29.9%, a $75 annual fee plus, after the first year, a $12 per month fee. Unlike First Premier's credit card (one of the handful of other unsecured subprime cards out there), Continental's does not require payment of fees before activation. However, after the first year a customer using the full credit line would pay total fees and interest per year greater than the amount borrowed.
Qualified nonbanks should be able to issue on all networks, without bin rental. And they should have the same preemption, rules and regulation that banks do. Continental's customers, like those of all other card issuers, will be protected by the CFPB.
There's lots of talk about making more credit alternatives available to the underserved, to whom banks won't lend—but unjustifiable roadblocks remain. These people need better access to financial services, but like the rest of us they deserve transparency, clarity and fairness.
Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian.