How do they monitor credit card risk?

The purpose is to calculate who may be a credit risk and methodically weed them out of the mix. If consumers use their credit cards at secondhand clothing stores, or discount grocers, lenders are taking note. The assumption is that if a consumer uses certain stores, they could be in financial strains. Based on purchasing behaviors, creditors are making decisions about consumer’s creditworthiness and changing the terms of the credit agreement accordingly.

Congress is getting involved, however. Federal regulators are looking into the extent to which credit lenders are using shopping information against consumers. It’s become a standard practice that if a consumer poses a credit risk, lenders either increase their interest rate, slash their limits or both. Federal regulators are trying to create a watchdog service to protect consumers’ rights.

A new credit card reform law

President Obama signed a new credit card reform law into action this year. There is a provision requiring a federal investigation into the practices of credit card issuers using shopping information against card users. Namely, lenders seem to be using information about where consumers shop, what they purchase, the category of merchants they shop with, their locations and the mortgage company they work with as a basis for increasing rates or reducing limits. US Representative Maxine Waters said, “Where a person shops, in my opinion, has little bearing on whether they can pay back a credit card balance… I want this study done because I want to stop some of these outrageous practices in the future.”

Reporting on lenders

The Federal Reserve and Federal Trade Commission have until August 22 to gather information on credit lenders and assess whether or not they are unfairly watching consumer’s habits. Regulators have to decide if negative profiling affected minority and low-income credit card users. American Express is one issuer of credit cards that acknowledged its former usage of profiling information to limit the amount of credit it extended to customers, though they have since discontinued the practice.

Waters added, “I’m concerned that limiting credit based on where a person shops or neighborhood they live in could amount to red-lining.” Red-lining is the practice of targeting specific demographic areas or neighborhoods for the purpose of discriminatory housing, insurance or lending actions.

Address privacy issues

In addition to not being fair to consumers, there are privacy questions to address. “Obviously that is something that most credit card holders are not going to think about,” said Paul Stephens, director of policy and advocacy for the Privacy Rights Clearinghouse. “They’ve obtained a credit card and think they can go out and use it in any way they like.”

Suggestions from experts

Until rules are sorted out, many experts are encouraging cardholders to pay with cash, use gift cards or prepaid debit cards in lieu of their credit cards. Shopping at wholesale outlets or discount grocers may also thwart profiling. One expert suggests spreading purchases over a few credit cards to avoid triggering alerts for a single lending company. Stephens added, “Cash is the ultimate privacy protector. It’s kind of hard to trace. With most other payment mechanisms, there is going to be a trail.”

Banks have suffered through the recession with huge mortgage industry defaults, but a new fear that credit cards will do the same is looming. Ken Lewis, Bank of America CEO, stated he believes that despite the government’s $700 billion rescue program, it will be “an awful year” for credit cards and companies that issue them.

It’s estimated there are almost $76 billion in credit card loans, and more than half of that debt is held by Bank of America, JPMorgan Chase and Citigroup.

The charge-off rate

Already setting the stage for disaster is the banking industry’s estimate that  their charge-off accounts have reached a historic high of 7.73 percent. Most experts anticipate that figure will increase, as the unemployment rate is still dangerously high.  This rate is commonly accepted as the most accurate indicator of future losses in the banking, mortgage and credit card industries.

Analyst Mike Taiano believes that the charge-off rate could be higher than 10 percent by year’s end. “With the economy the way it is, most consumers are still struggling. … Though there are some indicators that we are through the recession, there is still a long way to go to recover,” he said.

Bracing for the loss

Unlike the recession of the ’80s, when unemployment rates ran high also, this generation brings its own set of problems. First, new proposed legislation is set to allow consumers to request their banks reduce their mortgage debt if they have filed bankruptcy. Experts are fearful that this will cause more people to file bankruptcy so they can default on credit cards and other outstanding debts.

On the brighter side

David Robertson, publisher of the Nilson Report, stated that it’s “encouraging” that banks are adept at maneuvering recessionary periods after “years of practice.” When facing credit card losses, they know what cautionary actions to take.

For example, banks are slashing limits already and raising interest rates to bring in as much revenue as possible.  They are also working their customer service teams exceptionally hard, encouraging communication with customers. American Express is a leader in the mitigation process and recently offered their credit card holding customers a $300 cash-back return if they paid their account balances off and the closed their accounts before April.

Citibank

There is also news that Citibank is joining the ranks of a banks coming up with strategies to mitigate loss.  The company is looking to work out a joint venture for its private credit card division that serves retailers, as a way of moving out of the credit card business altogether.  However, experts say Citibank is alone in wanting to distance themselves from the credit card industry.

Most banks know they will have a difficult time attracting a completely new set of customers and would rather work hard to keep the ones they have, while easing their own risk.  Stuart Gunn, director of Bridge Strategy Group, stated: “If you want to be the retail bank of choice, it means you have to have CDs, debit cards, home equity loans and credit cards. Do you really want to exit one of the major lines of business?”