HOLLYWOOD, Fla. — Despite there being a potential "lull" in product innovation as financial firms prepare for a more stringent regulatory landscape, the ongoing financial crisis underscores the need for a stronger and safer consumer credit system, a top Federal Reserve official said Tuesday morning.
"I have every confidence that competition will ultimately restore innovation, but with products that are safer, simpler, and more transparent to consumers," Fed Governor Elizabeth Duke said, outlining five principles that she believes can guide industry and policymakers toward "balancing access to credit and sound risk management."
Those five principles: enhanced consumer protection, prudent underwriting, transparency, easy to understand credit disclosures and retail mortgage contracts, and rules that stifle competing interests that negatively impact consumers. If employed effectively, these principles could protract the "robust system" that Duke said is necessary for economic growth.
Duke delivered remarks here to members of the Consumer Bankers Association, which is comprised of retail-banking companies that provide a range of financial services, including automotive finance, mortgage lending, educations loans, investments and card products.
According to the association, its members hold two-thirds of the sector's total assets. Last month, the Federal Deposit Insurance Corp. said banks and thrifts reported income of $18 billion in the first quarter of 2010, up from $5.6 billion in the first three months of 2009 and a loss of $1.3 billion in the fourth quarter of last year.
New regulations being drafted by lawmakers will require financial institutions to make drastic changes to their business practices, design and products, Duke said at the banking conference.
The end result: banks' ability "to build profitability models around penalty pricing such as overdraft fees or raising rates on existing credit card balances" will be reduced, she said.
Looking to make lemonade from lemons, Duke said a positive outcome from the crisis will be that consumers are likely to be wary about taking on debt, unless they have appropriate financial stability. "In combination with regulations that require creditors to consider the borrower's ability to pay and disclosures that are clear about the cost of credit, these hard lessons could lead to more sustainable credit decisions by lenders and borrowers alike," the former community banker said.
Duke has previously said the overall economy faces considerable challenges. In her prepared remarks, Duke cited harsh statistics. Following the worse recession since the Great Depression, household net worth declined about 25% from peak to trough during the downturn, about 20% of mortgage borrowers are underwater and the unemployment rate remains high, at 9.7%.
Regarding credit availability, Duke pointed to diminished supply and weakened demand as contributing factors of that strain.
"While much of the decline in outstanding credit reflects elevated charge-offs and tighter lending standards, consumer cautiousness about debt appears to also play a role," she said.
Additionally, fewer new credit line accounts are being created, Duke said, noting that "a significant net fraction of lenders still report reductions in credit card line availability and the volume of new credit card offerings is only a fraction that of pre-crisis levels."
This is coupled with senior loan officers at commercials banks continuing to report weak demand from borrowers for mortgage and consumer loans.
Duke also highlighted concerns about the volatile stock market, despite the net worth recovery some experienced as markets showed signs of normalizing.
Aside from defending a series of Fed actions and measures taken in an attempt to thwart the crisis, Duke went on to explain other initiatives the Fed is working to develop--which include new mortgage standards that would better clarify adjustable rates, revised credit card fee disclosures rules and enhanced consumer protection, particularly related to overdraft fees, among others.
"Reinvention will bring uncomfortable change and uncertainty, but I believe that we are on the right path," Duke said.
During the question and answer period, Duke was asked about her concern for the retail-banking industry over the next 20-to-25 years. Duke said she has no long term concern, but she did say retail banks are likely to face difficulty over the next couple of years as they adjust to new regulations.
Duke did not provide an outlook for monetary policy or the economy in her remarks.