It is difficult to think of a product as commonplace in terms of use, yet so lightly regulated, as the credit card. Today, regulation of the credit card industry is primarily in the area of disclosures. These regulations typically mandate credit card companies to provide certain important information to consumers so that they can use this information to compare credit card products. Usually, regulators mandate the disclosure of information that they feel consumers “deserve to know.” This “moral-based” system of disclosure, however, has failed to adequately inform consumers, and has had little effect on the behavior of credit card companies.
“Safety Sells: The Case for an Incentive-Based Credit Card Disclosure System,” a report released today by the Center for American Progress, argues that to more effectively influence the behavior of credit card companies, an incentive-based system of disclosure—one that relies on the profit-seeking interest of companies to change their behavior—should be added to the current credit card disclosure regime. A good model for developing an incentive-based credit card disclosure system may already exist. At least, that appears to be the case with respect to the federal government’s New Car Assessment Program.
Congress called for the creation of NCAP in response to mounting concern raised in the 1960s and early 1970s about the safety of automobiles. At that time, injury and fatality rates related to automobile accidents were on the rise. Similarly, rising credit card indebtedness today threatens the financial and often personal well-being of millions of Americans and their families.
NCAP is just one component of a comprehensive regulatory regime that included specific regulations governing the manufacturer of automobiles as well as the establishment of several federal oversight bodies. But unlike the more traditional regulations that were designed to restrict the behavior of manufacturers, the purpose of NCAP was to “encourage manufacturers to make safety improvements to new vehicles and provide the public with information on the relative safety of vehicles.” To this end, NCAP instituted a five-star rating system that created an incentive for companies to produce safer cars.
The results have been dramatic:
- From 1979 (the first year that NCAP performed its frontal impact test) to 2006, the number of five-star rated cars (for the driver’s side only) increased by 1,800 percent, jumping from just three percent of the cars tested in 1979 to 57 percent of cars tested in 2006. Over this same period, the number of one- and two-star rated cars plummeted, dropping from 47 percent of cars tested in 1979 to zero percent in 2006.
- From 1997 (the first year that NCAP performed side impact tests) to 2006, the number of five-star rated cars (driver side) increased by more than 1,200 percent, jumping from just four percent of the cars tested in 1997 to 54 percent of cars tested in 2006. The number of one- and two-star rated cars fell from 28 percent to one percent.
- The results for rollover resistance testing demonstrate that safety ratings can lead to • changes in industry behavior in a short period of time. In just six years, from 2000 (the first year that NCAP performed rollover resistance tests) to 2006, the number of four- and five-star rated cars more than doubled, jumping from 32 percent of the cars tested in 2000 to 75 percent of cars tested in 2006. By comparison, the number of one- and two-star rated cars dropped from 23 percent to just one percent. The rollover results suggest that incentive-based disclosure systems have the most immediate impact in reducing the number of unsafe products. Also, given that behavioral changes occurred so suddenly, the results suggest that the ratings themselves are a key impetus for change as opposed to mere independent technological improvements.
These results show that an incentive-based safety disclosure system can have dramatic effects on the behavior of companies. This gives reason to believe that an “incentive-based” model would be a powerful tool for influencing the behavior of credit card companies as well. A system for credit cards could be modeled after the NCAP system, perhaps using a less detailed red-yellow-green formulation instead of the five-star crash rating system.
Specifically, like NCAP’s system, an incentive-based system for credit cards could:
- Empower the Federal Trade Commission to assess the safety of a credit card by testing for a limited set of credit card features that are deemed the most risky for consumers, among them: unilateral “at any time, for any reason” provisions for changing the rate of interest on credit cards; universal default provisions; the underwriting standards used to issue the card; the card’s interest rate spread between the introductory rate and the maximum rate allowed; and retroactive application of interest rate increases.
- Assign a red rating if the feature in question is below a pre-established basic standard of safety, a yellow rating if the card meets the basic standard of safety, and a green rating if the card exceeds the basic standard of safety.
- Require credit card companies to display the government safety rating on the card itself, as well as on credit card contract. The rating label on the contract should explain the basis for each of the cards safety ratings and the maximum available rating.
- Develop a public education component for the new rating system that explains the ratings to consumers in a clear and concise way, and provides consumers with a list of available government resources online and in print to help address any questions they have about the safety ratings system.
Read the full report