Consumer Compliance Outlook: First Quarter 2009

Final Rules on Credit Card and Overdraft Practices

By Barry L. Cutler, Consumer Regulations Specialist, Federal Reserve Bank of Philadelphia

Editor's Note: Congress subsequently enacted the Credit Card Accountability Responsibility and Disclosure Act of 2009, which the CFPB implemented as Sub-Part G to Regulation Z (1026.51-61 External Site). The Act and these regulations superseded the regulations discussed in the article. Outlook published an article on the Credit CARD Act regulations, which can be accessed here. The discussion of the Regulation DD overdraft disclosure and the overdraft proposal under Regulation E are still valid.

"The revised rules represent the most comprehensive and sweeping reforms ever adopted by the Board for credit card accounts. These protections will allow consumers to access credit on terms that are fair and more easily understood."

Federal Reserve Chairman Ben S. Bernanke, December 18, 20081

On December 18, 2008, the Board of Governors of the Federal Reserve System (Board), the Office of Thrift Supervision (OTS), and the National Credit Union Administration (NCUA) (the agencies) jointly announced a final rule2 banning five unfair credit card practices using their rulemaking authority under §18(f)3 of the Federal Trade Commission Act (FTC Act) to prohibit unfair or deceptive acts or practices (UDAP) by banks, savings and loan associations, and federally chartered credit unions, respectively.4 The rulemaking was closely followed by consumers, the banking industry, other regulators, Congress, and the media. The Board received more than 60,000 comments on the proposal, the highest number the Board has ever received on a rulemaking proposal. The final rule is effective July 1, 2010.

On the same day, the Board announced three complementary consumer protection rulemakings: 1) a final rule under Regulation Z, the implementing regulation for the Truth in Lending Act (TILA), making comprehensive changes to the regulation's open-end credit sections (excluding home-secured open-end credit); 2) a final rule under Regulation DD, the implementing regulation for the Truth in Savings Act, requiring new disclosures for financial institutions that offer overdraft protection services on deposit accounts; and 3) a rulemaking proposal under Regulation E, the implementing regulation for the Electronic Fund Transfer Act, prohibiting two overdraft protection practices. This article will review the events leading up to these rulemakings and highlight the major changes under the final rules, except for the Regulation Z amendments, which are discussed in detail in a separate article on page 4.


The agencies' rulemaking notice discusses the events that influenced their decision to exercise their UDAP rulemaking power to prohibit unfair acts and practices. For the Board, this process began with its project to conduct a comprehensive review and update of Regulation Z. To assist with the review, the Board retained Macro International, a research and testing consultant, to conduct consumer testing of the regulation's existing disclosures. Testing revealed that consumers' understanding of many of the disclosures could be enhanced by modifying their layout and wording.

Testing also revealed the limitations of disclosure-based consumer protection, namely, that it is not always possible to disclose a complex credit practice in a meaningful manner that most consumers can understand. Disclosure-based protection assumes that if the terms and conditions of a product or service are properly disclosed, consumers can make informed decisions. However, consumers cannot make informed decisions about products or services whose terms and conditions they do not understand and that are too complex to explain through disclosure. As the Board noted in the final rule: "Although the testing assisted the Board in developing improved disclosures, the testing also identified the limitations of disclosure, in certain circumstances, as a means of enabling consumers to make decisions effectively."5

A second influence on the Board's decision to consider using its UDAP rulemaking authority was the extensive public comments it received in response to its proposed amendments in June 2007 to the open-end credit sections of Regulation Z. Many commenters "urged the Board to take additional action with respect to a variety of credit card practices, including late fees and other penalties resulting from perceived reductions in the amount of time consumers are given to make timely payments, allocation of payments first to balances with the lowest annual percentage rate, application of increased annual percentage rates to pre-existing balances, and the so-called two-cycle method of computing interest."6

The OTS was also considering exercising its UDAP rule-making authority for the institutions it regulates. In August 2007, it published an advance notice of proposed rulemaking to determine whether it should expand its current UDAP prohibitions to include rules for credit cards, mortgage lending, gift cards, and deposit accounts.7 During the comment period, the OTS heard from consumers and some members of Congress, who urged the OTS to adopt the "principles-based standards" used by the FTC for its credit card rulemaking. Commenters also suggested that the OTS specifically address certain practices, including universal default, over-the-limit fees caused solely by penalty fees, payment allocation rules, subprime cards with high fees and small credit limits, and payment cut-off times.

The agencies also obtained additional information about credit card practices by examining their consumer complaint files for the institutions they supervise, by conducting outreach with industry and consumers, by reviewing several studies of credit card practices (such as the 2006 U.S. Government Accountability Office report Credit Cards: Increased Complexity in Rates and Fees Heightens Need for More Effective Disclosures to Consumers),8 and by monitoring several congressional hearings held in 2007 about credit card practices.

The agencies recognized the importance of consistency in their FTC Act regulations for credit cards. Credit card consumer protections should not vary simply based on the charter of the card issuer. As a result, they decided to jointly participate in an FTC Act rulemaking in May 2008. On December 18, 2008, they announced their joint final rule to prohibit five unfair credit card practices. The details are discussed below.


§227.22: Unfair Time to Make Payment

The final rule provides that card issuers cannot treat a payment as late for any purpose unless the consumer was given a reasonable amount of time to make payment. To ease the compliance burden, the rule contains a safe harbor for card issuers that mail or deliver periodic statements at least 21 days before the payment due date. The Official Staff Commentary for §227.22 clarifies that treating a payment as late "for any purpose" includes negative reporting to consumer reporting agencies, imposing any kind of fee, and increasing a cardholder's annual percentage rate (APR).

The rule addresses the problem experienced by some consumers who receive their credit card periodic statements too close to the payment due date, without sufficient time to review the charges and mail the payment, taking into account delays caused by mail delivery. While the industry protested that the rule was unnecessary because many consumers check their statements online and pay their bills electronically or by telephone, the agencies noted that their rules are designed to protect all consumers and that a large number of consumers still pay their bills by mail.

One complexity the agencies had to address in fashioning this rule is a provision in §163(a) of TILA stating that card issuers offering a grace period to avoid finance charges must allow at least 14 days between the time periodic statements are mailed and payments are due. As noted above, the new rule concerning time to make payment establishes a safe harbor if the issuer mails the periodic statement at least 21 days before the due date. Thus, card issuers theoretically could have two deadlines for consumers on the periodic statement: one for the grace period to avoid finance charges (at least 14 days) and one to avoid a late fee (21-day safe harbor). The final rule states that issuers can identify two different deadlines on the periodic statement, though the agencies anticipate that many issuers will simply choose one deadline (21 days or longer) to avoid consumer confusion arising from two separate due dates.

§227.23: Unfair Allocation of Payments

This rule addresses the common card issuer practice of allocating payments first to the balance with the lowest APR when an account has multiple balances and APRs. This practice results in maximizing interest charges that consumers pay. The final rule requires that when a consumer sends a payment that exceeds the minimum payment on an account with multiple balances and APRs, the issuer must allocate the payment in excess of the minimum payment using one of two allocation methods: 1) applying the payment to the balance with the highest APR first and any remaining portion to the other balances in descending order based on the applicable APR; or 2) distributing the payment pro rata to all of the balances, i.e., in the same proportion as each balance bears to the total balance.

To ease the compliance burden for issuers using the pro rata method, the agencies clarify that issuers are not required to deduct the minimum payment from the total balance when allocating among the balances. Issuers also have the option of simplifying the allocation process by applying one of the permissible allocation methods to the entire payment instead of using one allocation method for the minimum payment and another for the excess amount. To further aid compliance, the agencies include examples of payment allocation in the Official Staff Commentary to §227.23 of the final rule.

§227.24: Unfair Acts or Practices Regarding Increases in Annual Percentage Rates

Many card issuers reserve the right in their cardholder agreements to increase a card's APR at any time, for any reason. Such increases can cause hardship for consumers who rely on the APR in effect when selecting a card and when using that card for transactions. To address this concern, the final rule prohibits issuers from raising APRs except in certain circumstances. Specifically, the rule is subject to five exceptions: 1) if a rate disclosed at account opening expires after a specified period of time, issuers may apply an increased rate that was also disclosed at account opening (for example, "5 percent on purchases for six months, then 15 percent"); 2) issuers may increase a rate due to the operation of an index (in other words, the rate is a variable rate); 3) after the first year for a new account, issuers may increase a rate for new transactions but only after complying with the 45-day advance notice requirement in the amended Regulation Z;9 4) issuers may increase a rate if the minimum payment is received more than 30 days after the due date; and 5) when an issuer lowers the APR as part of a workout and the consumer defaults, the issuer can restore the APR in effect before the workout.

The final rule will affect credit card deferred interest plans because issuers will no longer be permitted to assess interest retroactively if the consumer does not pay a balance in full by the end of a specified period. However, issuers could offer plans where interest is assessed on purchases at a disclosed rate for a period of time but the interest charges are waived or refunded if the principal is paid in full by the end of the period.

§227.25: Unfair Balance Computation Method

When the Board published its June 2007 proposed amendments to Regulation Z, it received comments from consumers, consumer groups, and a member of Congress urging the Board to prohibit the double-cycle (also known as two-cycle) billing method. This method averages a cardholder's balances for the last two billing cycles. In certain situations, double-cycle billing results in consumers paying finance charges on balances that were already paid. This occurs when a consumer pays off a balance entirely in one billing cycle, thus avoiding finance charges, but then makes a partial payment on the balance in the next billing cycle. Because double-cycle billing examines two billing cycles, finance charges are being assessed in part on a balance the consumer already paid in full. Double-cycle billing does not harm consumers who avoid finance charges by paying their bills in full each month or revolvers, who always incur finance charges because they make only partial payments on their bill each month.

The final rule prohibits institutions from imposing finance charges on consumer credit card accounts based on balances for days in billing cycles that precede the most recent billing cycle as a result of the loss of a grace period. An exception is made for adjustments to finance charges as a result of a dispute resolution and adjustments to finance charges resulting from a returned payment for insufficient funds.

§227.26: Unfair Charging of Security Deposits and Fees for the Issuance or Availability of Credit

The last rule addresses concerns about subprime credit cards. These cards, which are marketed to consumers with low credit scores and weak credit histories, typically offer very small credit limits (e.g., $300) and high mandatory fees. The final rule prohibits card issuers from financing security deposits and fees for credit availability (for example, account-opening fees) if the charges assessed during the first 12 months would exceed 50 percent of the initial credit limit. The rule also prohibits issuers from imposing during the first billing cycle security deposits and fees that exceed 25 percent of the initial credit limit. Any additional amounts, up to 50 percent, must be distributed evenly over at least the next five billing cycles.10

Four Proposed Rules That Were Not Adopted

Readers who followed the agencies' May 2008 proposal will recall that the agencies had originally proposed prohibiting seven credit card practices and two overdraft protection service practices. Two of the proposed credit card rules and the two overdraft practice rules were not adopted.

The first proposed credit card rule not adopted would have prohibited card issuers from imposing a fee for exceeding a credit limit that results solely from a hold placed on the account. The agencies stated that based on the comments they received, fees resulting from holds on credit card accounts are not a significant issue. The second proposed credit practice concerned "firm offers of credit" under §1681b(c)(1) of the Fair Credit Reporting Act that stated multiple or a range of APRs. The agencies stated that their concerns about these types of offers are sufficiently addressed by the Board's final amendment to §226.5a(b)(1)(v) of Regulation Z, making a separate UDAP rule unnecessary.

Regarding overdraft protection services, the agencies had proposed two rules. The first proposed rule would have prohibited financial institutions from imposing overdraft fees unless consumers were offered a partial or complete opt-out of the service. The second proposed rule would have prohibited institutions from imposing an overdraft fee when it resulted solely from a hold placed on an account in excess of the actual transaction amount.

After reviewing comments, the agencies decided that greater consumer protections would be provided if the rules regarding overdraft protection services were adopted by amending Regulation E using the Board's authority under the Electronic Fund Transfer Act rather than by using the agencies' UDAP authority under the FTC Act. For example, state-chartered credit unions are not covered by the agencies' UDAP rule-making but are subject to Regulation E.


The two rules concerning overdrafts that the agencies originally proposed under their UDAP rulemaking authority are now contained in a new Regulation E proposal. The new proposal modifies the proposed UDAP overdraft rule concerning opt-outs. Financial institutions would be prohibited from imposing overdraft fees unless they offered an opt-out but only for overdrafts resulting from ATM withdrawals and one-time debit card transactions. They would not have to offer an opt-out that also applied to checks (as originally proposed). Testing revealed that consumers found overdraft fees acceptable in the context of checks because if they opted out of the check service, the check would not be paid, yet they still would be charged an insufficient funds fee that is generally equivalent to an overdraft fee. Another change is that the new proposal includes, as an alternative approach, an opt-in. Under this approach, institutions could assess overdraft fees only to consumers who affirmatively consented to the service. The Board will review public comments in deciding which approach, if any, to adopt in the final Regulation E rule.

The Board indicated that it would specifically like to receive comments on a number of issues, including 1) whether the scope of the proposed opt-out should be expanded from ATM withdrawals and one-time debit transactions to also include recurring debit card transactions and ACH transactions; 2) whether 30 days is sufficient time to opt out or whether a shorter time frame, such as 15 or 20 days, may be more appropriate; 3) whether the Board should require institutions to provide a toll-free telephone number to ensure that consumers can easily opt out; 4) whether the Board should add examples of methods of opting out that would not satisfy the requirement to provide a reasonable opportunity to opt out, such as requiring the consumer to write a letter to opt out; 5) whether there are more effective means of ensuring that consumers are not discouraged from opting out of an institution's overdraft service for ATM withdrawals and one-time debit card transactions; and 6) an appropriate implementation period for the final rule.

The second rule in the new proposal is similar to the one originally proposed under the FTC Act. It would prohibit financial institutions from imposing an overdraft fee that would not have occurred but for a debit hold placed on funds in the consumer's account that exceeds the actual amount of the transaction. The revised proposal is limited to debit holds placed in connection with transactions for which the actual purchase amount can be determined within a short period of time following authorization (e.g., a gasoline purchase at the pump).


Overdraft Disclosure

To help alert consumers to the cost of incurring overdraft services on deposit accounts, the Regulation DD final rule requires financial institutions that offer overdraft services on deposit accounts and provide periodic statements to list on the statement the total amount of overdraft fees and the total amount of returned item fees incurred during the statement period as well as for the calendar year-to-date. The regulation already imposes this requirement for institutions that promote overdraft services. The new rule applies to all institutions offering overdraft services on deposit accounts, regardless of whether they promote the service.

Overdraft Account Balances

The second requirement under the final rule is that when an institution discloses a single account balance through an automated system, such as an ATM receipt, automated telephone banking, or website, it cannot include any of the following in the account balance: the amount of overdraft protection, funds that will be paid by the institution under a service subject to the Board's Regulation Z (e.g., a line of credit), or funds transferred from another account. However, the final rule does permit institutions to list two balances: one with the actual account balance that does not include these funds, and a second balance that includes these funds, provided the institution prominently states that the second balance includes these funds.


This article summarizes the key changes in the new consumer protection rules under the final amendments to Regulations AA and DD as well as the issues raised by the Regulation E proposal. Readers interested in more details can consult the final and proposed rulemaking notices on the Board's website.

Because of the significant changes to these regulations, banks should begin to assess their impact on the banks' systems, and begin working on updating and testing their systems to ensure they are in compliance by the July 1, 2010, effective date. Specific issues and questions should be raised with the consumer compliance contact at your Reserve Bank or with your primary regulator.