WASHINGTON — After months of pressure from House Financial Services Committee Chairman Barney Frank, the Federal Reserve Board has begun quietly working on a proposal that would define unfair and deceptive lending practices, according to sources familiar with the situation.
The Office of Thrift Supervision, the only other banking regulator with statutory authority to define such practices, moved forward with a broad plan this month, but the sources said they expect the central bank to take a narrower tack.
“The Federal Reserve Board is actively considering a rule-writing approach of its own,” said an industry source, who spoke on condition of anonymity. “The Fed is addressing a similar set of [unfair and deceptive practices] issues as the OTS” did.
The sources cautioned that the proposal remains in an early phase and that the central bank may ultimately abandon its plan to write a rule. But the Fed is in discussions with the OTS and the National Credit Union Administration, which has the authority to define unfair practices for credit unions, on what practices should be targeted, sources said.
“We are beginning the rule-writing process for credit unions, and we are engaged in sharing information with both the Fed and OTS on this,” an NCUA spokesman said. “I do think discussions are in process with the agencies to begin writing rules.”
In an interview Thursday, Sandra Braunstein, the director of the Fed’s division of consumer and community affairs, declined to discuss the issue directly but said, “We are not taking anything off the table, including writing UDAP rules under the FTC Act.”
Depending on how far it goes, a Fed rule defining unfair and deceptive acts and practices could have a significant impact on banks’ lending standards. Under the law, the Fed has the power to single out any practice across the range of the financial services industry, including credit cards, mortgages, and other types of consumer lending.
The OTS issued a tentative proposal Aug. 6, proposing to look broadly at mortgage, credit card, and deposit account practices. The agency invited the Fed to work with it on the project, but sources said the Fed declined. One source said the Fed has some concerns about details on mortgages and credit card practices outlined in the OTS’ advance notice of proposed rulemaking.
For example, the OTS proposal asked whether credit card companies should be required to apply payments first to higher-interest balances and be barred from charging fees that would force a customer’s account to be overdrawn. The source said that the Fed staff considers such prohibitions to be too broad. Another source said the Fed does not want to end up holding banks to a higher standard than other lenders.
Fed staffers are also said to be concerned about whether the OTS will seek to ban certain mortgage practices, including changing loan terms upon default and failing to employ reasonable loss-mitigation measures before initiating foreclosure, the source said.
The Fed is already wrestling with writing rules to enforce two other laws that may overlap with its FTC Act effort.
Fed Chairman Ben Bernanke has told lawmakers that the Fed would propose a rule by yearend under the Home Ownership and Equity Protection Act to address abuses in the subprime market. On May 23 the Fed issued a proposal governing credit card disclosures under Regulation Z, which enforces the Truth-in-Lending Act.
Any rule defining unfair and deceptive practices would probably come after the other two efforts are completed. Until now, however, Fed officials have signaled that they would not use their authority under the FTC Act but, instead, would focus on case-by-case supervision.
“Rules seeking to define all the circumstances when a particular practice is unacceptable can be too narrow or too broad, and as a result they may be ineffective or have unintended consequences,” Fed Gov. Randall Kroszner said in a June hearing. “In our view, enforcement of the FTC Act on a case-by-case basis, reinforced by agency guidance that establishes standards and recommended practices, is a more effective way to address these concerns.”
But the Fed has been severely criticized by Rep. Frank for failing to write rules under the FTC Act. At the June hearing, he threatened to take away its power to define unfair and deceptive practices and give it to the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp.
The Massachusetts Democrat subsequently gave the Fed until September to act and said last week that the OTS’ move reinforced his view “that we should take the power away from the Fed and give it to the OCC and FDIC.”
The Federal Trade Commission Act, passed in 1914 and substantially amended in 1975, shielded depository institutions from the FTC’s enforcement authority. Congress instead left it up to the Fed to write rules identifying unfair and deceptive practices for banks, to the OTS to write rules for thrifts, and to the NCUA to write rules for credit unions.
But the agencies have used that power sparingly. In 1985 the Fed and OTS issued rules defining unfair and deceptive practices for certain consumer credit practices. The NCUA followed suit in 1987. The OTS has also issued a rule concerning unfair and deceptive acts in advertising.
Industry representatives are wary of rules defining unfair practices but have said that, if any are written, they should be proposed by all four banking and thrift regulators. Wayne Abernathy, the executive director of financial institutions policy and regulatory affairs at the American Bankers Association, said that if the Fed ultimately does write a proposal, it should do so carefully.
If the Fed needs to write a rule, it should “focus on practices rather than on particular products,” he said.
“If the focus is on products, you decrease the availability of the industry to innovate and bring more people into the financial mainstream or to adjust to the financial needs of our customers. The problem isn’t with the product, it is how you are using them.”
