Statement of Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
on
Improving Federal Consumer Protection in Financial Services;
before the
Financial Services Committee; U.S. House of Representatives;
2128 Rayburn House Office Building
June 13, 2007
Chairman Frank, Ranking Member Bachus and members of the Committee, I
appreciate the opportunity to testify on behalf of the Federal Deposit Insurance
Corporation (FDIC) regarding ways to improve federal consumer protection in financial
services. The examination by the Committee of existing federal consumer protection
safeguards is timely in light of recent regulatory and judicial decisions that have
preempted state consumer protection laws for federally chartered financial institutions
and their non-bank subsidiaries, as well as for out-of-state branches of state chartered
banks through the operation of the Riegle–Neal Interstate Banking and Branching
Efficiency Act of 1994.
In recent years, the U.S. financial system has been the source of extraordinary
economic innovation. New products and processes ranging from credit cards, to internet
banking, to securitization have substantially altered the choices and opportunities
available to consumers. In turn, these new financial tools have helped to support
generally strong and stable U.S. economic growth over the past two decades.
While the impact of innovation in the financial system has generally been positive, not
all consumers have benefited. Many of these changes have been accompanied by
pitfalls for the financially unwary or unsophisticated. This has resulted in financial
distress for a number of consumers and has highlighted the importance of having a
state and federal legal framework that provides consumers with the information and
tools necessary to protect against unfair or exploitive products and practices.
My testimony will discuss some of the broad changes to the financial system and the
challenges they are creating for consumers. It also will discuss the current legal tools
available to regulators and how they are used to protect consumers. Finally, my
testimony will discuss reforms that would improve the ability of consumer protections to
keep pace with innovation in the financial marketplace.
Developments in the Financial System
Advances in technology and changes in lending organization structure have resulted in
financial products that are increasingly complex and marketed through increasingly
sophisticated methods. The pace and complexity of these advances heighten the
potential risk for consumer harm. Consumers today often face a bewildering array of
choices, especially in the credit options available to them. For example, there are
seemingly unlimited types of credit cards, each with its own particular terms and
Federal Deposit Insurance Corporation
on
Improving Federal Consumer Protection in Financial Services;
before the
Financial Services Committee; U.S. House of Representatives;
2128 Rayburn House Office Building
June 13, 2007
Chairman Frank, Ranking Member Bachus and members of the Committee, I
appreciate the opportunity to testify on behalf of the Federal Deposit Insurance
Corporation (FDIC) regarding ways to improve federal consumer protection in financial
services. The examination by the Committee of existing federal consumer protection
safeguards is timely in light of recent regulatory and judicial decisions that have
preempted state consumer protection laws for federally chartered financial institutions
and their non-bank subsidiaries, as well as for out-of-state branches of state chartered
banks through the operation of the Riegle–Neal Interstate Banking and Branching
Efficiency Act of 1994.
In recent years, the U.S. financial system has been the source of extraordinary
economic innovation. New products and processes ranging from credit cards, to internet
banking, to securitization have substantially altered the choices and opportunities
available to consumers. In turn, these new financial tools have helped to support
generally strong and stable U.S. economic growth over the past two decades.
While the impact of innovation in the financial system has generally been positive, not
all consumers have benefited. Many of these changes have been accompanied by
pitfalls for the financially unwary or unsophisticated. This has resulted in financial
distress for a number of consumers and has highlighted the importance of having a
state and federal legal framework that provides consumers with the information and
tools necessary to protect against unfair or exploitive products and practices.
My testimony will discuss some of the broad changes to the financial system and the
challenges they are creating for consumers. It also will discuss the current legal tools
available to regulators and how they are used to protect consumers. Finally, my
testimony will discuss reforms that would improve the ability of consumer protections to
keep pace with innovation in the financial marketplace.
Developments in the Financial System
Advances in technology and changes in lending organization structure have resulted in
financial products that are increasingly complex and marketed through increasingly
sophisticated methods. The pace and complexity of these advances heighten the
potential risk for consumer harm. Consumers today often face a bewildering array of
choices, especially in the credit options available to them. For example, there are
seemingly unlimited types of credit cards, each with its own particular terms and
conditions. Consumers now have choices beyond the traditional fixed-rate mortgage
that include adjustable rate or nontraditional products that are tied to a variety of
amortization schedules and arcane index rates. In many cases, it is difficult even for
sophisticated consumers to fully understand the costs associated with particular credit
options or to compare alternative products.
Another significant development in banking has been the increasing impact of fees on
the overall cost of financial products. For example, typical credit cards now include
higher and more complex fees than they did in the past. As noted in a recent study by
the Government Accountability Office, “Controversy surrounds whether higher fees and
other charges are commensurate with the risks that issuers face.”1 The application of
over-limit fees illustrates this problem. While issuers typically do not reject cardholders'
purchases during a sale authorization even if the transaction will put a cardholder over
the card's credit limit, they will likely later assess the same cardholder with an over-limit
fee and also may impose a higher interest rate.
Similarly, while depository institutions have paid overdrafts on a discretionary basis for
many years, a substantial number of institutions now routinely provide fee-based
overdraft protection programs to their customers rather than offering traditional overdraft
programs, such as lines of credit or linked accounts. Fee-based overdraft protection
programs typically charge customers at least $20 - $35 for each overdraft. Depending
on the size of the overdraft and length of time for repayment, the effective annual
percentage rate (APR) can exceed 1000 percent. When used to cover the occasional
overdraft, these programs can be beneficial. However when used repeatedly as a
source of credit, they are extremely high priced.
Although we do not have pure fee statistics available, trends in the growth of noninterest
revenue2 underscore the banking industry’s increasing reliance on fee-based sources of
income. Last year, insured institutions obtained 42.2 percent of their net operating
revenue (net interest income plus total noninterest income) from noninterest income.
Ten years ago, the share was 34.3 percent. Twenty years ago, it was 29.4 percent.
During the past 20 years, the average annual rate of growth in noninterest income for
the industry has been 8.4 percent. During that same period, the average annual growth
rate in net operating revenue has been 6.4 percent. The growth of fee income is not per
se harmful and has helped keep banks strong in an era of narrow net interest margins.
However, as noted below, fee structures are problematic if they are poorly disclosed or
so complex that consumers are unable to understand them.
Another significant change in the financial system has been the increased participation
by providers other than banks and thrift institutions. For example, one estimate shows
that some 52 percent of subprime mortgage originations in 2005 were carried out by
companies that were not subject to examinations by a federal supervisor.3 There also
has been dramatic growth in both transactions services and small denomination
consumer loans outside of the banking system by firms commonly called “alternative
financial services providers.” These firms, which include pawn shops, rent-to-own-
stores, check cashing firms, and payday lenders, tend to provide relatively high-cost
financial services to people of modest means. While estimates vary, some place the
that include adjustable rate or nontraditional products that are tied to a variety of
amortization schedules and arcane index rates. In many cases, it is difficult even for
sophisticated consumers to fully understand the costs associated with particular credit
options or to compare alternative products.
Another significant development in banking has been the increasing impact of fees on
the overall cost of financial products. For example, typical credit cards now include
higher and more complex fees than they did in the past. As noted in a recent study by
the Government Accountability Office, “Controversy surrounds whether higher fees and
other charges are commensurate with the risks that issuers face.”1 The application of
over-limit fees illustrates this problem. While issuers typically do not reject cardholders'
purchases during a sale authorization even if the transaction will put a cardholder over
the card's credit limit, they will likely later assess the same cardholder with an over-limit
fee and also may impose a higher interest rate.
Similarly, while depository institutions have paid overdrafts on a discretionary basis for
many years, a substantial number of institutions now routinely provide fee-based
overdraft protection programs to their customers rather than offering traditional overdraft
programs, such as lines of credit or linked accounts. Fee-based overdraft protection
programs typically charge customers at least $20 - $35 for each overdraft. Depending
on the size of the overdraft and length of time for repayment, the effective annual
percentage rate (APR) can exceed 1000 percent. When used to cover the occasional
overdraft, these programs can be beneficial. However when used repeatedly as a
source of credit, they are extremely high priced.
Although we do not have pure fee statistics available, trends in the growth of noninterest
revenue2 underscore the banking industry’s increasing reliance on fee-based sources of
income. Last year, insured institutions obtained 42.2 percent of their net operating
revenue (net interest income plus total noninterest income) from noninterest income.
Ten years ago, the share was 34.3 percent. Twenty years ago, it was 29.4 percent.
During the past 20 years, the average annual rate of growth in noninterest income for
the industry has been 8.4 percent. During that same period, the average annual growth
rate in net operating revenue has been 6.4 percent. The growth of fee income is not per
se harmful and has helped keep banks strong in an era of narrow net interest margins.
However, as noted below, fee structures are problematic if they are poorly disclosed or
so complex that consumers are unable to understand them.
Another significant change in the financial system has been the increased participation
by providers other than banks and thrift institutions. For example, one estimate shows
that some 52 percent of subprime mortgage originations in 2005 were carried out by
companies that were not subject to examinations by a federal supervisor.3 There also
has been dramatic growth in both transactions services and small denomination
consumer loans outside of the banking system by firms commonly called “alternative
financial services providers.” These firms, which include pawn shops, rent-to-own-
stores, check cashing firms, and payday lenders, tend to provide relatively high-cost
financial services to people of modest means. While estimates vary, some place the