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Update Newsletter: Summer 2008

Proposed Changes to Regulation Z: Highlighting Behaviors That Affect Credit Costs

Analysts in the Payment Cards Center have been actively following and participating in the public dialogue on the Federal Reserve's efforts to revise credit-card disclosure requirements as defined by Regulation Z. In June 2005, the PCC hosted a forum on the subject that brought together leading scholars, industry executives, and policy experts to consider the role of disclosure practices as part of broader consumer protection regulation.1

Some two years later, the PCC hosted a workshop to discuss several of the thenproposed revisions to disclosure requirements and related research by Jeanne Hogarth, program manager in the Consumer Education and Research section of the Board of Governors' Division of Consumer and Community Development Studies and Education. Hogarth discussed a recent paper identifying certain behaviors most likely to affect the interest rates consumers may pay for borrowing and related these findings to the Board's proposed changes to Regulation Z.2 PCC Analyst Ann Kjos has summarized Hogarth's talk in a discussion paper, "Proposed Changes to Regulation Z: Highlighting Behaviors That Affect Credit Costs."3 PDF The paper details Hogarth's argument that disclosures providing easily understood information about critical credit card terms and conditions will lead consumers to make more financially efficient decisions.

Hogarth's research highlighted specific behaviors having significant effects on the interest rate consumers are charged on credit cards. The data used to test these behaviors were based on the Federal Reserve's periodic Survey of Consumer Finances. After testing a number of factors against the interest rate on a consumer's primary credit card, the researchers identified five statistically significant behaviors: paying off credit card balances, paying bills on time, shopping for credit, becoming more financially educated, and decreasing credit use. The intuition gained from this analysis is that the price consumers pay for credit is not only affected by these behaviors but can also be altered by modifying damaging financial practices.

In relating her research findings to the Board's proposed changes to Regulation Z, Hogarth focused on the rules covering two critical sources of information available to credit card users: the initial card solicitation, which gives consumers information about the credit offering, and the periodic billing statement, which updates consumers on the status of their accounts. In her discussion of solicitation documents, Hogarth focused on the proposed disclosures for interest rates and fees and a proposal to provide a reference to an educational website hosted by the Board.

In addition to the research conducted by Hogarth and others, the Board made extensive use of consumer testing to help inform its proposed disclosure revisions. Such testing by the Board revealed, for example, that the way in which many card issuers allocate repayments to various balance types — that is, purchase transactions, balance transfers, cash advances, and so forth — was generally found to be confusing for consumers, prompting one set of revised disclosures. Another area of confusion revealed by consumer testing related to the number of new fee categories, such as set-up and maintenance fees and various penalty fees, now common practice in many subprime card offers. By putting these fees in one easy-to-understand format, the Board's proposed revisions are designed to help borrowers gain a better understanding of the full cost of the credit offered.

These and other proposed changes reflect and support Hogarth's research finding that comparison shopping is an important determinant in minimizing the cost of using credit cards. In addition, the Board has also proposed requiring credit card issuers to include a reference on all credit card solicitations to a new informational website hosted by the Federal Reserve, a requirement also supported by Hogarth's finding on the relevance of financial literacy in affecting the price of credit.

As for the proposed disclosure changes to credit card billing statements, Hogarth focused on four areas: information about late payments, a new notice about the effect of minimum payments, rules about communicating changes to account terms, and simplifying descriptions of multiple fee/interest rate categories. In discussing the proposed changes, she gave examples for each of the areas and then related the proposed changes to her earlier research findings. For example, the proposal to more prominently display the payment due date as well as including a specific late payment warning on statements is intended to reinforce positive consumer behavior associated with paying bills on time.

Since the workshop was held, the Board has made a substantive change in its approach to consumer protection regulation. In addition to further refinements to the proposed changes to Regulation Z, the Board recently announced a number of proposed rules that go beyond information disclosures and are directed at prescribed practices, including new limitations on the payment allocation practices noted earlier.4 A number of the proposals relate to areas where Hogarth's research and the Board's consumer testing revealed continued confusion on the part of consumers.