Fed: Small Business Credit Card Reform Not Worth Costs

Giving small businesses the same credit card protections that consumers now have is not worth the potentially higher costs and reduced credit, the Federal Reserve Board said in a report issued late last week.

Small businesses typically have higher credit lines than consumers, and it’s harder for banks to evaluate the risk of business borrowers, the Fed report said, so restricting banks’ ability to raise interest rates could mean higher costs and tighter credit up front:

[C]redit card issuers have more difficulty assessing the creditworthiness of small businesses than consumers. Therefore, the willingness of issuers to extend the relatively large credit card lines that small businesses require may depend importantly on issuers’ ability to adjust prices in the future, as they learn through experience about businesses’ ability and willingness to pay. Restricting the ability of card issuers to adjust interest rates may lead to higher initial interest rates, which would harm those firms that borrow on small business credit cards.

The report was due to Congress May 22 as part of the CARD Act, the consumer protection law passed last year. The CARD Act limits some practices by credit card companies most criticized by consumer advocates, like raising interest rates on existing balances and applying payments in a way that maximizes interest costs to the borrower. Those changes do not apply to small business credit cards, which account for about 15 percent of payment card spending, according to an estimate by Ken Paterson of research firm Mercator Advisory Group.

Bank lobbyists praised the Fed report. The American Bankers Association opposed the original credit card reform, warning that parts of the law “will undermine the availability of credit.”

Still, it’s not clear how much restricting banks’ ability to raise rates on old balances will curtail credit. Bank of America announced in April that it would voluntarily give small business cards the protections extended to consumers under the CARD Act. The bank doesn’t expect the change to hurt its ability to extend credit, spokeswoman Betty Reiss told me in April.

There’s some evidence small businesses could benefit from a ban on retroactive rate hikes. Advanta, the now-bankrupt credit card lender which once had 1.3 million small business customers, last year settled with regulators over accusations of “unfair and deceptive practices” involving repricing balances. That settlement affected at least 138,000 borrowers who signed up for cards at low interest rates that later jumped after they had run up balances. Some of them are still paying off charges at APRs over 30 percent.

Some more useful context from the Fed report: Most small businesses pay their cards off each month, rather than using them as a source of credit. Only 18 percent of firms with fewer than 50 employees carried a monthly balance on their credit cards in 2009, the report says (citing a survey by the NFIB). That’s about the same as in 1998, and less than the 23.6 percent that borrowed on credit cards in 2003, according to Fed surveys. The share of business owners that carry a balance on small business credit cards (rather than personal cards) has more than doubled from 5.9 percent to 12.3 percent since 1998, the report says.

Still, the Fed doesn’t recommend giving that growing share of business card borrowers the same protections consumers got through the CARD Act.

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