The arguments over the CFPB's late-fee rule were settled a decade ago

Yurii Kibalnik - stock.adobe.com

Earlier this year, the Consumer Financial Protection Bureau proposed a rule that would functionally cap credit card late fees at $8 per infraction, down from a range of $30 to $41. The CFPB estimates that banks' revenue from late fees is five times greater than the additional costs they incur, and that the excess penalties are not needed to deter late payments by consumers.

With CFPB poised to finalize the rule, industry and other critics of the proposal have been pushing back, raising the alarm that a fee cap will lead to higher interest rates, reduced credit access and other unintended consequences.

If this line of argument seems familiar, it's because it is. In 2009, Congress passed the CARD Act, which eliminated credit card over-limit fees and took steps to address some of the issues with late fees. In a failed attempt to torpedo the bill, critics raised an almost identical set of points.

I was a graduate student in economics when the CARD Act was debated and followed the back-and-forth with interest. While I was worried that excessive fees were taking advantage of consumers, I was also concerned that regulation might have unintended consequences for interest rates and credit access. A few years later, as a young professor at the University of Chicago, I got the chance to work with data that could answer these questions. I jumped at the opportunity.

Our study, which was published in one of our profession's most prestigious journals, used detailed data on over 160 million credit cards to examine the intended and possibly unintended effects of the CARD Act regulation of credit card hidden fees. The main findings, which were confirmed in follow-up academic and government studies, can be summarized as follows:

First, we found that the fee caps saved consumers $11.9 billion a year with no corresponding increase in interest rates or other charges or fees. Intuitively, the reason was that credit card lending was highly profitable, allowing banks to absorb the losses out of their margins. In addition, banks were already charging the highest interest rates market forces would permit, limiting their ability to offset the lower fees with higher interest charges.

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Second, we found no evidence of reduced credit access, either as measured by credit limits or approvals of new credit card applications. This was true even when we focused on lower credit score consumers, who are most exposed to changes in bank lending.

Third, we found that the reduction in late fees had no impact on the frequency of late payments. Consumers pay late not because they strategically weigh the benefits of late payment against the cost of the late fee but because they forget or are unable to come up with the cash. This rejects the creative argument that high late fees could help consumers, encouraging them to make on-time payments and avoid any blemishes on their credit reports. 

Competition is the bedrock of our economic system and is the primary force for ensuring low interest rates and quality service in the credit card market. However, when it comes to excessive late fees, we cannot rely on competitive forces alone. Consumers are naturally optimistic they will make on-time payments and may not allocate enough attention to late fees when comparison shopping for cards. Banks want to avoid habitually tardy payers and may avoid marketing strategies that highlight low late fees.

While banks should be able to charge fees to cover the additional cost of processing late payments, bank revenue models based on excessive late fees have troubling equity implications. Late fees disproportionately burden those living in low-income and minority neighborhoods. Within communities, a small share of borrowers account for most of the fees. Indeed, it's hard to think of a revenue model with worse equity implications than one that by design targets those who are struggling the most to pay.

Policy decisions are often made with incomplete or imperfect evidence. While prior experience does not guarantee future performance, I have rarely seen a policy debate where we have such a strong and relevant evidence base to draw from. And the smart money is betting on the evidence. When CFPB announced their lower-than-expected fee cap, Wall Street concluded the lower fee revenue would come out of profits and pushed down the stock prices of the most exposed firms.

According to CFPB calculations, an $8 fee cap could save consumers about $9 billion per year. The evidence from the CARD Act should limit our concern about unintended consequences. A fee cap would have important equity implications, delivering the largest savings for low-income, minority and otherwise vulnerable consumers. And it would be another important step in moving us away from a fee-based consumer finance system that generates the most revenue from those who can least afford it. The CFPB should finalize the rule.