Lawmen ride in to credit 'Wild West'

Analysts have likened the credit card industry to the Wild West and looking back at the sub-prime era before the crunch, it is difficult to argue with this assessment.

According to estimates by Bloomberg, America's five biggest card issuers, Citigroup, JP Morgan Chase, American Express, Bank of America and Capital One could have $72.3 billion (Dh265.55bn) in credit-card losses – wiping out their collective $49bn in net income from credit-card operations for the four years since 2005.

So when US President Barack Obama signed into law last week sweeping reforms that include a restriction on credit card interest rates and fees, it was seen as the sheriff finally coming to town.

The Credit Card Accountability, Responsibility and Disclosure Act (CARD), which will be in force from February next year, also requires issuers to tell cardholders how long it will take to pay off a balance and what it will cost in interest if they only make the minimum monthly payments.

Charges for paying late or exceeding a card's limit typically bring an estimated profit margin of 60 per cent to 70 per cent – an important part of a lender's business model. The average US household debt by credit cardholders who carry a balance is around $17,000 and Americans pay around $15bn in penalty fees.

It is hoped that the new law will bring much respite to consumers with the average American carrying more than five credit cards, according to the Nilson Report, an industry newsletter. "We're not going to give people a free pass; we expect consumers to live within their means and pay what they owe. But we also expect financial institutions to act with the same sense of responsibility that the American people aspire to in their own lives," Obama said.

The issue of responsibility and credit is of course not just an American problem and in recent months the UAE has seen a curb on the amounts consumers can borrow with some banks slashing credit limits for existing customers and raising the threshold of requirements for new borrowers.

And earlier this week, RAK Bank said local lenders were seeing an increase in the number of customers who "skip" the country without paying off their credit card bills – between 1,500 to 2,500 every month over the last six months.

Local lenders typically receive interest rate yields of around 24 per cent from credit cards. Meanwhile, the Emirates Inter-bank Offered rate (Eibor), the cost of borrowing for institutions, is around two per cent.

Driven by the margins on offer, banks are still pushing credit card products in a relatively aggressive manner judging by anecdotal evidence of the frequency of cold calls to potential customers offering new cards – apparently targeting professionals from specific industries, earning above a minimum salary threshold. Experts say that this kind of "segmenting" does not take fully take into account an individual's ability to pay back what he or she has borrowed and underlines the need for a more regulated credit card sector in the UAE. The way credit cards are issued in the UAE is still a frontier business.

So, will the sheriff be coming to this town any time soon?

According to Emcredit, the UAE's pioneer information services company, a major step has been taken towards the kind of regulation the US has put in place. A draft law on credit information was passed in March by the UAE's Federal National Council.

When the law is enacted "it will allow information to be shared and enhance the flow of information and at the same time put in place the necessary policies to ensure the confidentiality of such information," says Zaid Kamhawi, Chief Business Officer, Emcredit. "The US has a developed market because it has a very mature credit reporting industry and can assess to a high degree the risk profile of an individual and can tailor interest rates appropriately. Without that information, you end up applying the same interest rate across the board whether the customer is high or low risk, so in developing markets the good customers get penalised."

Currently, credit card issuers rely on a wide variety of customer information when deciding if an applicant should be given a card and what limit to set for it, segmenting customers based on criteria including salary levels and the length of time in a job.

Vimal Kumar, Senior Vice-President and Cards Business Manager, Mashreq, says: "In the UAE, in the absence of a credit bureau, banks assess customers creditworthiness by evaluating factors such as the tenure at the current job, how leveraged he is in terms of other financial obligations, his current income, his current repayment behaviour and regulatory checks in terms of Know Your Customer checks to ensure that we track legitimacy of the customer earning his income through rightful means. Mashreq has made investments in technology and resources to develop statistical score models to assess the risk profile of customers."

HSBC also uses a stringent set of tests when deciding on who should get credit in the Emirates. "We use a variety of techniques such as negative data, policy (such as age), observation of the use of other products with us, scoring – i.e. the use of past experience to predict future behaviour – fraud checks and in exceptional cases verification by phone. Techniques are monitored and altered continuously to ensure that we keep up with the changing market," says Thimal Perera, Regional Head of Cards, HSBC Middle East.

However, the flaw in all these systems, no matter how advanced the technological set up an institution may have, says Emcredit, is that the banks must rely to a certain degree on the customer to provide as much information as possible. Credit scoring can only be as accurate as the historical data provided will allow, leaving the system open to abuse and making it difficult for banks to pass on savings to customers with good credit histories.

"There needs to be a fundamental improvement in the type of information banks collect – they rely on individuals, what is called 'information asymmetry.' An individual will only give you information he will want to give you. Three months of bank statements doesn't tell you that much in terms of credit history," says Kamhawi. "In the absence of information that allows the banks to more accurately segement customers by their profile they end up segmenting by salary – but payment habits are a behavioural thing. You can still earn a high income and be a defaulter or be highly leveraged."

And in what is still a developing economy with varied demographics and levels of customer sophistication, are consumers offered a high level of protection? Or is it a case of caveat emptor – buyer beware? Mashreq's Vimal Kumar says: "Customers in the UAE are very credit card savvy" and they need to be. Using the new US legislation as a loose benchmark, many UAE banks, unsurprisingly, do not currently practice all of what US banks will be required to do from next year. While roughly half the lending institutions do post credit card terms and conditions online, most do publish a summary of their fees and charges on their websites. Information in general is hard to come by without specifically requesting it and it is worth also to periodically contact your lender for any changes. Most issuers are not required to warn you of changes within any specified period. However, Kumar says that Mashreq is a "transparent, fair and relationship" driven bank and that "typically for any rate change, the customer is informed a minimum of 30 days in advance through our various touch points. [We] do not shift payment due dates without the customer's consent."

HSBC states on its website in the terms and conditions for its Premier Credit Card that it "reserves the right to amend the finance charge and other charges from time to time, at its discretion." But HSBC's Perera insists that "as a responsible lender, we always give prior notice to our customers."

Barclays says in regards to its Barclaycard: "Apart from changes to our interest rates which we can apply immediately, most changes will happen at least 30 days after we tell you about them so that you will have sufficient notice of them." However, the mode of how customers are informed can vary from direct mail to a statement on the issuer's website and the onus is on the customer to be alert to any changes in terms and conditions.

Ultimately, due to the infancy of the UAE credit card industry, the current system can at times penalise the credit worthy and reward the less credit worthy. It is here that Obama's concept of consumer responsibility must be borrowed and used until law and industry practice fills the gaps. While institutions do their best to sort the wheat from the chaff, it is also up to the credit cardholder or applicant to be fully aware of the risks so that he or she does not end up in a situation where they feel they need to "skip" town without paying their bills.


Under the new us credit card law

- Credit card issuers will be required to tell cardholders how long it will take to pay off a balance and what it will cost in interest if they only make the minimum monthly payments

- Retroactive rate hikes that appear on a bill "suddenly with no rhyme or reason" will be barred, said US President Barack Obama 

- Companies will have to post their agreements online

- Companies will have to mail statements 21 days before payment is due, instead of 14

- Shifting payment dates will be prohibited

- 45 days' notice will be required for changes in terms and conditions.

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