WASHINGTON — A pending proposal from the Federal Reserve Board would prevent credit card companies from raising interest rates on customers' existing debt for any reason other than a default on the card account, several sources said Monday.
The plan, which is expected to be released Friday at a meeting of the central bank's board, is tougher than expected.
Sources have said the proposal would curtail double-cycle billing and provide guidance on the allocation of payments.
But its treatment of so-called risk-based repricing, a fundamental strategy for some card companies, such as Bank of America Corp., went further than anticipated, many said. Industry representatives are already mobilizing against the plan, arguing that curbing the practices will cause companies to recoup revenue in other ways, such as higher fees.
"We oppose the imposition of government controls on risk-based repricing systems," said Scott Talbott, a lobbyist with the Financial Services Roundtable.
Restricting it this way "would eliminate credit or make it more expensive to get credit," he said.
Ken Clayton, the director of the American Bankers Association's Card Policy Council, agreed the changes could bring back wider use of annual fees and increase interest rates across the board.
"If you can't price for risk on interest rates, you'll have to deal with it in other ways," he said. "If you take away our ability to price for risk, to charge interest on a loan, and to price our product, it's going to result in higher prices for consumers, less access to credit, and less choice. "
Though banks are poised to fight the proposal, many do not see much hope the central bank will yield.
"However tough it is, they are unlikely to retreat from it," said a large-bank lobbyist, who spoke on condition of anonymity. "They might consider industry comments and fine-tune it, but this strikes me as an inevitability, that the industry is going to be fundamentally changed."
Currently card companies are allowed to use outside factors to increase a customer's rate, including defaults elsewhere, decline in credit quality, or an increase in banks' costs of funds.
Under the proposal, card issuers would be allowed to consider outside factors to increase rates for new transactions, sources said, but not on existing balances. Banks would still be able to raise rates when a customer defaults on that account, but the Fed is expected to define such a circumstance.
Under a proposal already put forward by the Fed last year that implements Regulation Z, which governs credit card disclosures, card companies would also have to give consumers advance notice of any rate change and the ability to opt out. The Reg Z proposal is expected to be amended when the Fed meets on Friday in order to better coordinate it with the central bank's new proposal governing unfair and deceptive card practices.
Sources said the central bank may require banks to give customers advance notice and the ability to opt out of overdraft programs as well, sources said.
It is unclear if the Fed's plan will be aggressive enough to ward off congressional intervention. Risk-based repricing, which is loosely referred to as universal default, has come under siege on Capitol Hill, and eliminating it has been a cornerstone of several bills.
At an April 17 hearing House Democrats vowed to press onward with a bill from Financial Services Committee Chairman Barney Frank, D-Mass., and Rep. Carolyn Maloney, D-N.Y., that would rein in credit card practices regardless of the Fed's proposal. The bill would ban companies from increasing rates on outstanding debt and charging interest on debt already paid, commonly referred to as double-cycle billing.
A separate bill from Rep. Maloney would also require consumers to opt in to overdraft protection. The bill has stalled in the committee and is unlikely to move forward without changes that allow it more bipartisan support.
Rep. Spencer Bachus of Alabama, the top Republican on the House Financial Services Committee, who has expressed frustration with many credit card practices, has invited the top six issuers to meet May 5 to discuss their reactions to the Fed's proposal.
Some said the Fed's harsher view of credit cards was driven in part by more political pressure.
"It's going to be tougher than what some people first thought," said Oliver Ireland, a former Fed lawyer who is now a partner in the Washington office of Morrison & Foerster LLP. "They have been criticized for having not acted and they have taken those criticisms to heart and are trying to do a credible job in addressing them."
The Fed has also announced it intends to handle payment allocation rules in which banks usually apply payments to the lowest interest rates first.
That practice, too, has come under fire from lawmakers, particularly Sen. Carl Levin, D-Mich., and Rep. Maloney.
A bill introduced by Sen. Levin last year would stipulate that banks apply payments to the lowest interest rate first, while Rep. Maloney's would require banks to apply payments proportionally to different interest rates.
Though it was still unclear how the Fed would treat payment allocation, some sources said a proportional application of payments was more likely than the upending of the practice altogether.
Senate Banking Committee Chairman Chris Dodd, D-Conn., is also expected to introduce sweeping credit card legislation this week.
Some consumer groups said that unless the Fed takes a firm stance on double-cycle billing, just curbing risk-based repricing is not enough.
The changes "are extremely modest," said Ed Mierzwinski, the consumer program director for U.S. Public Interest Research Group. "The Fed has had broad authority that it has failed to use for many years to adequately protect consumers. … I hope the proposal will be worth the paper it's printed on."
Though banking groups were preparing to object to the changes and consumer groups were expecting the Fed plan to fall short of their goals, it was unclear what impact the repricing change reform would have once implemented.
Within the last year at least two big issuers, Citigroup Inc. and JPMorgan Chase & Co., announced they would stop repricing based on external risk factors during the term of the card contract.
Bank of America still uses risk-based repricing, and Capital One reprices its customers when their cost of funds rate increases.
"Most of the big players have already stopped doing this," said Jaret Seiberg, an analyst with Stanford Group Co.
