I am sure all your speakers begin their remarks by telling
you how happy they are to be addressing you.
I am no different in that respect, but I am particularly sincere in
saying that, because this speech provides an opportunity to knit together
several important subjects in the retail banking arena: the significance of the
retail banking business today and some particular concerns we have with how it
is being conducted; how those concerns interact with broader supervisory and
regulatory policy perspectives of the OCC; and thoughts on potential
consequences for the industry of the convergence of questionable retail banking
practices with our supervisory and policy concerns and objectives.
We are talking about an enormously important segment of the
banking business today. The consumer
accounts for no less than two-thirds of all U.S. economic activity, and its
widely agreed that the extent to which consumer confidence bounces back -- as
it appears to be doing -- after its recent decline will go far in determining
the magnitude and duration of the economys recovery.
Consumer attitudes and behavior are also of profound importance
to the banking system -- and always have been.
But consumer behavior now affects the financial services industry more
directly than ever before. During the
past two decades, the growth in loans to individuals -- and the declining
prominence of commercial and industrial loans -- have been perhaps the most
dramatic of the many changes that have occurred in bank portfolios. At the same
time, banks have grown increasingly reliant on non-interest income, derived
increasingly from their retail customers. In 1983, banks earned nearly nine
dollars in interest income for every dollar of non-interest income. In 2001, the ratio was down to less than
three to one.
So while unemployment rates, wage growth, housing prices,
household debt burden, and other consumer-related measures have always been
full of meaning for banks, they have never had a more immediate bearing on the
industrys bottom line than they do today.
Given this reliance, one might assume that banks would be
bending over backwards to cultivate and retain their retail customers. Indeed,
some are and the effort is usually well rewarded. But we have observed too
many banks engaging in retail banking practices that are hard to defend, either
from consumer protection or safety and soundness perspectives. Bankers who
invent new fees to impose on consumer transactions, or who arbitrarily raise
their existing fees, or who engage in fine-print slight-of-hand about how those
fees are calculated and applied, risk alienating customers and driving them into
the arms of non-bank competitors.
The loss of retail customers en masse would be
a serious blow to any business that depends upon them as much as depository
institutions do today. But taking those customers for granted or being
insensitive to their needs and interests -- presents additional risks to
the industry. When retail customer
practices by some institutions are abusive, unsavory, unfair, deceptive or
unsafe and unsound, those practices may provoke a legislative response -- or a
reaction from bank regulators -- that will affect all the institutions engaged
in that line of business. The result
might be a loss of flexibility by all, and costly new burdens on an entire
banking sector. And, in the broadest
sense, consumer-unfriendly banking practices are counterproductive to the
countrys economic recovery.
I know that last point might strike some as a stretch. But
when we were checking the latest report on consumer attitudes from the
University of Michigan, we happened upon another report prepared by researchers
at the same institution, which concluded that customer satisfaction was the
most important leading indicator of consumer spending more important than
income changes and consumer confidence combined.
Think about that for a moment. If these researchers are
right, then the quality of the interaction between consumers and
merchants does more to determine whether that consumer keeps coming back for
more and continues to do his or her part to fuel the economy than anything
else. In other words, it appears that for a significant percentage of the
American public, unpleasant, unproductive, or disillusioning retail experiences
can have a chilling effect on future spending depriving the economy of the
stimulus from which it would otherwise benefit.
These macroeconomic considerations buttress the case for
vigorous supervision of retail banking activities for the benefit of banks and
their customers and for prompt and decisive supervisory intervention when we
find patterns of conduct incompatible with safety and soundness, as well as
with the letter and the spirit of consumer protection laws.
Unfortunately, questionable practices are not rare
especially in the credit card business, which generates more customer
complaints than any other retail banking activity. Thats been the case since the OCC began collecting and
tabulating customer complaints relating to national banks in the late
1990s. But consumers with credit
card-related complaints have become more vociferous -- and the issues they
raise more serious over the past several years.
Certainly the OCC has taken these complaints seriously and
has acted vigorously to combat the abuses that we discover. In 2000, we
investigated charges that Providian National Bank was engaging in unfair and
deceptive credit card marketing practices practices that affected literally
hundreds of thousands of customers. To
resolve that dispute, Providian entered into a consent decree that not only
assured that the practices we cited would come to a halt, but also provided
hundreds of millions of dollars in restitution to customers who had suffered
harm. In the last half of 2001, we arrived at similar consent decrees with two
other national banks found to have engaged in unfair and deceptive practices
in their credit card operations. And a fourth national bank whose business was
predominantly credit-card related was closed early in 2002 after its unsafe and
unsound practices depleted its capital.
These actions, I think, demonstrated our strong commitment
to protecting consumers, to upholding the reputation, as well as the safety and
soundness of the national banking system, and to safeguarding the public
interest. Yet, as already noted, there
was continuing and growing evidence reported both by consumers and our
examiners -- that the problems that Ive just mentioned -- and the practices
that gave rise to them -- were becoming sufficiently pervasive industry-wide to
warrant a more comprehensive and systematic response.
Thats why the OCC, along with the Federal Reserve, FDIC,
and OTS, last year began to develop guidance focusing on account management
practices for credit card lending -- issues with safety and soundness as well
as consumer protection implications. And this past January, the agencies issued
new guidance intended to address those problems. The guidance is significant both for what is says, and because
the agencies had to issue it in the first place. Ill talk about each of these points in turn.
The guidance aimed to ensure that financial institutions
conduct credit card lending in a safe and sound manner by establishing sound
account management, risk management, and loss allowance practices. And it
spelled out our specific expectations in each area of concern: credit line
management, over-limit practices, minimum payments and negative amortization,
workout and forbearance practices, and income recognition and loss allowance
practices.
Our concern about credit
line management stemmed from the growing number of card issuers extending
and expanding credit without sufficient consideration of the cardholders
ability to repay. In some cases, having established a profitable relationship
with a borrower, lenders have gone on to increase credit lines or to issue
additional cards, including store-specific private label cards and affinity
relationships cards, without considering how such extensions might affect that
relationship or overextend the borrowers financial capabilities. Its not
unheard of for institutions to offer additional cards even to borrowers who
have already started to experience repayment problems.
The interagency guidance makes clear that lenders must
manage credit line assignments and increases responsibly, using proven credit
criteria. We expect institutions to test, analyze, and document line-assignment
and line-increase criteria, and to establish and strengthen internal controls
capable of determining the impact of additional credit lines on repayment
capability.
Overlimit practices have
been another matter of concern. We have found that account management
practices that dont control the authorization or provide for timely repayment
of overlimit amounts may significantly increase the credit risk profile of the
portfolio especially in the case of subprime accounts, where liberal
over-limit tolerances and inadequate repayment requirements can magnify the
high risk exposure to the lender.
The guidance stresses the importance of careful management
of over-limit accounts, to ensure that bankers are able to identify, measure,
manage, and control the risks associated with them. It puts banks on notice to
restrict over limit accounts, particularly those that are subprime, and to
subject them to appropriate policies and controls.
As regulators, we understand the competitive pressures under
which banks operate today. And we understand why banks might see it as
advantageous to adopt policies designed to maintain outstanding balances. But some institutions have crossed an
important line: theyve reduced minimum payment-due amounts on their cards to
the point that they fall short of covering all finance charges and fees
assessed during the billing period, so that the outstanding balance continues
to grow through negative amortization. At
the very least, minimum payments set at that level make very little progress in
reducing the amount owed.
But such minimum
payment and negative amortization practices also cross a regulatory line,
as our guidance makes explicit. First, reduced minimum payments may have the
effect (if not the intent) of masking declining credit quality and borrower
impairment. Second, they dig borrowers into an ever deeper hole, requiring
increasingly more difficult measures if borrowers are ever to pay their way out
of debt.
For those reasons, we expect financial institutions to
require minimum payments that will amortize the current balance over a
reasonable period of time. Low minimum
payments, especially when they result in negative amortization, are not
consistent with the principle that consumer loans should be repaid within a
reasonable period of time. As the
guidance states, negative amortization, inappropriate fees, and other practices
can compound or protract consumer debt and disguise portfolio performance. These practices raise safety and soundness
concerns and are subject to examiner criticism.
Although its only been in effect for several months, the
guidance has already produced several positive results. Its promoted a greater
understanding of the credit risk inherent in over-limit accounts, and has led
to a strengthening of over-limit practices.
It has generated a useful dialogue with the industry on the adequacy of
minimum payments; some institutions that had inordinately reduced their
minimums are in the process of raising minimum payments back in line with the
industry. It has encouraged the adoption of improved income recognition and
loss allowance practices, particularly for uncollectible accrued interest and
fees.
But, as important as the content of the guidance is the fact
that the guidance had to be issued in the first place. Allow me to elaborate on some lessons to be
learned from this development.
At the OCC, we support the ability of national banks to
conduct the banking business authorized under their federal charter, including
the products they are allowed to offer and the fees they are allowed to charge
for them. This assuredly does not mean,
however, that we will tolerate abusive or sly consumer banking practices by
national banks. We expect national
banks to treat their customers fairly and to exhibit the highest standards of
integrity in all their business operations.
Given the importance of consumer banking business these days, this
should be a business imperative. But,
where banks fail to do so, we have, and we will take action.
In general, our approach has been to address particular practices
by particular national banks.
Typically, we have tackled unfair, deceptive, unsafe or unsound
practices on an institution-specific basis.
We recognize that differences in conduct require different sanctions and
solutions, and that, on the other hand, different banks could have different,
but nevertheless appropriate ways of dealing with a particular consumer
issue. Our system of comprehensive
supervision of national banks enables us to address -- and not overreact to --
problems we identify. And, we have
believed that approaching practices through our supervisory process
enables us to more effectively deal with the circumstances presented by each
bank, and to design solutions customized to the practices, operations and risks
presented by each bank.
What is notable about the account management guidance issued
earlier this year is that it represents a departure from this approach. More telling is the reason why. To be blunt, some players in the industry
have been tone-deaf on key issues.
Despite the concerns we have expressed informally; despite the obvious
importance of the consumer business segment, some industry participants have
looked for any excuse to cut corners in customer treatment and drift to the
lowest common denominator of account management practices. Banks should not need to have regulators
instruct them on how to fairly treat their customers or fairly present their
financial performance. Indeed, in todays
post-Enron, post-Sarbanes-Oxley environment, managers of companies of all types
should be bending over backwards to assure that presentation of their financial
information best reflects the economic substance of their business. The fact that the agencies had to issue the
account management guidance reflects a failure to get it.
At the very least, enlightened self-interest should lead
bankers to embrace best practices and condemn any outliers for not doing the
same. The history of consumer regulation
and legislation teaches a valuable lesson here: When some institutions persist
in not getting it, the consequences ultimately are felt by all institutions,
when regulators -- or Congress -- react by setting comprehensive standards that
apply to all.
Applying this lesson in the context of the account
management guidance is important, because other issues remain, and to the
extent the relevant industry continues not to get it, the industry invites
another response from regulators that the industry may well not like. On the question of minimum payments, for
example, our guidance did not specify what might be a reasonable period of
time for an outstanding balance to be amortized. That raises the question of
whether the regulatory agencies should impose a limit on the amortization
period or require disclosure of the length of time to repay the indebtedness if
only the minimum payments are made.
Second, the guidance dealt with the question of negative
amortization in the context of minimum payments. But, it can well be argued
that negative amortization is a practice that should simply be eliminated. The
question is how to do that. A minimum payment that is quite sufficient to amortize the
debt alone might be inadequate if over-limit and late fees are added to the
financed amount. That would leave financial institutions with two unpalatable
choices: either raise the minimum amount or reduce fees.
Third, there are unresolved issues in connection with the
repayment of over-limit amounts. Again, part of the problem is definitional:
what constitutes timely repayment of such amounts, as called for in the
guidance? Obviously, over-limit amounts should be subject to more stringent
repayment requirements than the original balance. But having just undergone the
process of writing and vetting comprehensive guidance, there is an
understandable reluctance, on the parts of the industry and the agencies, to go
through the process yet again if satisfactory results can be achieved instead
through the supervisory process.
We believe that the supervisory process can produce
satisfactory results. For the agencies part, it requires that we clearly
convey our expectations to management.
In the coming weeks, our examiners will be doing just that. Whether we
wind up having to do more will depend on the industrys response. This is a
time for bankers to get it -- to demonstrate leadership of their own by
reforming their account management practices..
The interagency guidance and my remarks have detailed
issues arising in connection with credit card lending. But I want to emphasize
I could have been talking about other areas of retail banking. Payday lending. Skip payment plans. Debt
protection plans. Overdraft protection plans. Each of these banking products has
come in for different degrees of criticism.
By and large, many of these are not inherently bad or abusive products,
and no one would expect bankers to deliver them without being compensated for
their effort. Indeed, over the years the OCC has encouraged national
banks to look to fee income as a way to diversify their income stream, in order
to even out the oscillations in interest income that were so long a source of
industry instability. The impressive strength of the banking sector during
these trying economic times suggests that this strategy has borne fruit.
But continuing long-term success requires that as bankers
pursue more fee-based products and services and enhanced non-interest income,
they do so with particular consideration of fairness to customers and fair
presentation of their financial performance.
Much hinges on the decisions bankers will make regarding the terms on
which their retail products are offered and the clarity and integrity with which
the performance of those retail products is presented.
You face some important crossroads now in several retail
product areas. You have the opportunity
to establish a solid foundation for the long-term profitability and success of
those products. If you dont, you
undermine that foundation, and you enhance the likelihood that regulators will
conclude that we need to act, again.
Its up to you.
Thank you very much.