Fair Lending

Industry Watchdog Challenges DOD
On Possible Exemption for Credit Cards

By Karen L. Werner

Major banking groups are questioning whether credit cards should be covered by a new law designed to protect military service members from abusive lending practices, but an industry-funded watchdog is poised to challenge the Defense Department's authority to exempt the credit card industry.

Five banking associations are effectively asking DOD to limit the focus of the law to the payday lending industry.

However, the Center for Regulatory Effectiveness will file a legal opinion with DOD opposing this view. "The essence of the CRE's position is payday loans and credit cards are peas in the same pod," said Jim Tozzi, a member of CRE's board of advisers.

Section 670 of the National Defense Authorization Act for Fiscal Year 2007 limits the terms of consumer credit extended to service members and their dependents. One key provision of the law would prohibit banks from charging more than a 36 percent annual percentage rate for consumer credit extended to service members or their dependents.

The Defense Department is expected to issue implementing regulations by October 2007 with input from federal banking regulators.

Tozzi said his concern is that the Defense Department might interpret the law to apply just to payday lending.

While Tozzi said he is against any regulation of credit including payday loans or credit cards, he said if DOD is going to regulate credit instruments, it would have an anti-competitive impact just
to regulate some and not all of them.

According to Tozzi, the statute is very clear that it covers all credit instruments. He said that while the law does contain a provision that allows the Defense Department to define "creditor," other language in the statute constrains how this is interpreted. Tozzi also served as the first deputy administrator of the Office of Management and Budget's Office of Information and Regulatory Affairs.

Banks Seek Focus on Payday Loans

Meanwhile, Jan. 5, five banking associations effectively asked DOD to limit the focus of the law to the payday lending industry. The groups expressed concern in comments that because of the 36
percent cap their members "may find" they cannot offer military personnel and their spouses and dependents "their only viable credit card products."

The American Bankers Association, America's Community Bankers, Association of Military Banks of America, Consumer Bankers Association, and Independent Community Bankers of America filed the comments with DOD Jan. 5.

The groups said, "A broad application of the legislation could have the unintended effect of harming service members and their spouses and dependents by limiting their access to beneficial and common credit products or increasing their credit costs."

DOD should apply the regulation narrowly, focusing on payday loans, short-term loans covered under the Truth-in-Lending Act's Regulation Z.

The banks also expressed concern about the "all-in" annual percentage rate contemplated in the law.

Unlike current APRs disclosed to all consumers under TILA, the Defense Department authorization would include all fees associated with a loan, which would add a confusing, additional, non-comparable APR for military consumers to consider, the comments said.

This "artificially inflated" APR could mean that military personnel would not have access to certain products, the groups said.

"While a 36 percent APR that is charged based on the loan principal over the life of the loan is a comparatively high rate of interest, almost all credit cards provide for fees for some transactions, such as a cash advance fee, that temporarily inflate the APR for a single statement period, and when the balance on the account is low, may push the effective APR over the 36 percent cap," the groups said.

Additional fees included in the APR calculation would make it likely that an effective APR would exceed 36 percent as well, the groups said. Other limits to the interpretation of the
law are also needed, the groups said, such as ensuring that the regulation does not apply to loans and accounts in existence before the effective date of the regulation.

Also, lenders should be able to easily verify service members' eligibility under the regulation, the groups said.

Credit Unions Express Concern

In Jan. 10 comments, the Credit Union National Association similarly urged the Defense Department to limit the reach of the law to abusive predatory lending practices and predatory lenders, warning that if the law applies to credit unions, it could limit the products available to
military families.

According to NAFCU, "to conclude that the term "annual percentage rate" does not have the same meaning as it does for the purposes of TILA, the 36 percent annual percentage rate ceiling contained in the Defense Act would, in all likelihood, have unintended negative ramifications on the
availability of legitimate credit for American military families."

"Though certainly well-intentioned, applying interest rate caps, inclusive of all fees, to regulated financial products, when coupled with the potential imposition of monetary and criminal penalties for knowing violations, could cause credit unions to reduce or eliminate some extremely beneficial credit options currently available to the military," NAFCU added.

'Predatory Lending' Definition at Issue

CRE has already challenged the Defense Department report at the foundation of the law's provisions.

The center Sept. 21, 2006, filed a petition under the Data Quality Act asking the Defense Department to correct its report, "Report on Predatory Lending Practices Directed at Members of the Armed Forces and Their Dependents."

Under that petition, CRE argued that parts of the report did not comply with information quality standards, including its characterization of all payday advances as "predatory," which it said "lacks any sound factual or analytical basis and is biased."

Tozzi added that the report did not define "predatory lending," which also, "in our view" includes credit cards.

The Data Quality Act was enacted as part of the fiscal year 2001 omnibus spending bill (Pub. L. No. 106-554), which directed OMB to issue guidance to federal agencies to ensure the quality of information they disseminate.