The deadline to become compliant with the final rule on the “ability to pay” amendments to Regulation Z stemming from the CARD Act of 2009 passed last month. Financial institutions are breathing a sigh of relief and getting on with their business.
While that may sound nice, the reality for many financial institutions is that there is still much work to be done. Some institutions prepared months in advance of the final rules and implemented automated approaches that would not only help them become compliant but keep their offers of credit flowing. Others scrambled to get something in by the deadline after the final rules were revealed.
No matter what solution institutions implemented, the focus now must turn to maximizing capabilities to get the most out of their investment and evaluating whether their new approach is the best choice.
One of the most prominent changes of the proposed regulation is the need to include a consumer’s income or assets and current obligations when determining a consumer’s ability to pay. Fortunately, the final commentary clarified details surrounding this clause of the regulation.
First, in addition to a consumer’s income and assets, a card issuer “may also consider consumer reports, credit scores, and other factors consistent with Regulation B” when considering a consumer’s ability to pay. Second, when making the ability-to-pay calculation, a card issuer may use the consumer’s stated income or assets without conducting a separate verification of the information received from the consumer.
Finally, a card issuer also may consider income and/or asset information obtained from third parties or through any empirically derived, demonstrably and statistically sound model that reasonably estimates a consumer’s income or assets (i.e., an income or asset estimation model). These clarifications were critical in that they added a measure of certainty back into the lending equation, particularly with respect to instant prescreening.
While both instant prescreen and consumer initiated credit issuance are impacted by the new rules, the risk of losing major volume comes to those institutions using an instant prescreen business model that has not traditionally included income in their evaluative criteria.
If prescreen programs do not have consumer-friendly and compliant processes in place when incorporating the new “ability to pay” regulations, prescreen channels will feel a crunch from a drop in customer participation, bank approval rates and customer acceptance rates. This pessimistic scenario can be mitigated by paying careful attention to ensuring effective measures are incorporated into credit-issuing procedures limiting the loss of new prescreen customers and maximizing profitable growth.
The prerequisite to minimizing a negative impact to prescreen portfolios is automating the new required processes to decrease unfavorable customer experiences. There are several tools available on the market to estimate income and calculate each consumer’s ability to pay.
As institutions move beyond turning down applicants where income is not available, or performing extensive manual work to obtain this data, these models will increasingly be used in credit decisions. If the debt-to-income ratio verifies the customer can make the minimum payment, the lender can then determine the appropriate credit limit and card type when making an offer. While collecting additional data comes with challenges and added costs, it may represent a healthy return to the industry’s credit roots.
Capacity always has been one of the keys of credit lending. Many financial institutions have, over time, moved away from straight income-based models as other factors proved their predictability. The question is: will the explicit incorporation of income back into these models improve the long-term performance of the portfolio? Time will tell.
With the right tools issuers can modify decision criteria and credit offer specifics as needed to remain compliant and grow their business strategically.
Lenders must focus on an in-depth analysis to evaluate the measures they use and focus on making the new requirements as painless as possible for consumers while easing the impact to their business practices and risk exposure.
As auditors review the compliance practices that lenders incorporate, new standards likely will be revealed that need to be addressed. While getting compliant was the first step, the real work starts now.
Paul Thielemann is senior vice president of sales and marketing for Zoot Enterprises in Bozeman, Mont.