How to Cheat Customers Without Ruining Your Reputation
First Premier Bank has for decades offered credit cards with higher rates and fees than almost any other bank. For instance, if you borrowed $250 on one of their cards and held that balance for a year, you'd pay roughly 75% of that amount, $187.50, in finance charges and fees—assuming no late payment or other charges.
No cheating or deception — just an expensive card. Most bank subprime credit cards cost less than half that.
Despite intermittent flak from regulators and consumerists, this strategy for providing expensive credit to less creditworthy customers has worked like a charm. The bank's owner is said to have become a billionaire. First Premier didn't have to go on life support during the crisis.
This isn't surprising or heinous. It's part of what free enterprise offers us. Specifically, there are tens of millions of customers who want a credit card, want to build their credit — and can't get any other card without a heavy up front deposit and paying to borrow back their own money. Unsurprisingly, many consumers would rather pay a $50 fee now than tie up a $200 deposit indefinitely.
What might seem surprising is that this long-running success has attracted little competition, at least from major banks. Why — when most of the profitable checking customers can't qualify for any unsecured card from their own banks? Doesn't everything have its price?
The reason banks don't compete is the perceived reputation risk. They fear they'd look bad if they marketed cards at such high rates. They've told me that many times over the years.
But high APRs don't always give rise to perceived reputation risk. Some very large banks are offering short-term loans at much higher rates, well in excess of 100% APR. These products, sometimes called "deposit advances," embody a few wrinkles that shield banks from reputation risk.
First, the banks are seen as being on the side of the angels because they compete with nonbank payday lenders, so hated by consumerists — who are impatiently waiting for the Republicans to empower Mr. Cordray to wring those usurers' necks.
This perspective appears to date back to the FDIC's Guidance FIL-14-2005, which effectively encouraged banks to engage directly in payday lending — after regulators had previously discouraged this. (But the banks did not follow the FDIC's example in actually using the toxic term "payday lending"!)
Second, banks offer "deposit advances" mostly to current checking customers. Hence there is no blatant advertising exposure. Third, "deposit advance" isn’t a credit card, and hence avoids the most Draconian disclosure regulations.
Another example of avoiding reputation risk comes from the haunted realm of overdraft fees. Some banks, including large ones, started applying the customer's completed and paid debit card transactions to checking balances starting from the day's largest debit and going down to the smallest one — rather than in the order in which the transactions actually occurred and were authorized by the bank.
Sounds crooked? Indefensible. But this produces much higher overdraft revenue. What is stunning is that the banks evidently didn't see a lot of reputation risk in doing it. Why?
First, to even describe this swindle and give an example can take over 100 words. On the other hand, "75% APR" for a card consumes just a few keystrokes. Even now with the jig up, the perpetrators of the upside down overdraft fees only get a few inexplicit headlines, but come out way ahead financially — after paying the class action settlements.
This fiasco could have been avoided by the Fed's writing and enforcing more explicit regulations. No need for a CFPB. Example:
Fed regulations under the Truth in Lending Act spell out how to compute finance charges and APRs. It's very complicated, but it works. To write a regulation preventing cheating on overdrafts would be considerably simpler. One reason the same regulators didn't achieve this might be their obsessive focus on credit cards. (Moving this same cast of characters to the CFPB and then hiring more of the same won’t make them any more incisive.)
Reputation risk is a phantom in a hall of mirrors, keeping banks from profitably serving legitimate consumer needs. Yet in the future as in the past, fear of reputational damage won't keep seemingly upstanding banks from cheating their customers (even pension funds, aka widows and orphans). There will always be stealthier ways to do this, which banks see as risk-free.
It would be nice if we could rely on regulators for deterrence and enforcement, since class action lawyers seldom vindicate the public interest.
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. He can be reached at firstname.lastname@example.org.